STATE OF MICHIGAN INVESTMENT BOARD MEETING March 7, 2019 State of Michigan Retirement System Quarterly Investment Review
Rachael Eubanks, State Treasurer Prepared by Bureau of Investments Michigan Department of Treasury STATE OF MICHIGAN INVESTMENT BOARD MEETING
MARCH 7, 2019
Agenda
9:30 a.m. Call to Order and Opening Remarks
9:40 a.m. Approval of the 12/11/18 SMIB Meeting Minutes
9:45 a.m. Executive Summary & Performance for Periods Ending 12/31/18
10:00 a.m. Current Asset Allocation Review
Markets Review and Outlook
10:15 a.m. Review of Investment Reports Defined Contribution Fixed Income Real, Opportunistic, & Absolute Return Domestic Equity Private Equity – Receive and File International Equity – Receive and File Real Estate & Infrastructure – Receive and File
11:00 a.m. Public Comment
Closing Remarks ~ Adjournment
2019 Meeting Schedule
Thursday, June 6, 2019 Thursday, September 12, 2019 Thursday, December 12, 2019
All meetings start at 9:30 a.m.
www.michigan.gov/treasury State of Michigan Retirement System MINUTES State of Michigan Investment Board Meeting March 7, 2019
Jon M. Braeutigam Chief Investment Officer Bureau of Investments STATE OF MICHIGAN INVESTMENT BOARD December 11, 2018 Meeting Minutes
Members Present: Chair – Treasurer Nick Khouri Budget Director John Walsh (arrived 10:30 am) Ms. Dina Richard Mr. Reginald Sanders
Members by Phone: Mr. James Nicholson
Members of the Public and Bureau of Investments Staff Present: Molly Jason Craig Sabin Jack Behar Karl Borgquist Paul Lerg Richard Holcomb Mary Pollock Anthony Estell Kerrie VandenBosch Dave Klauka Matt Hutson Pavel Stolarczyk Barb Becker Craig Coulter June Morse Ann Stange Mark Porrell Nick Whitman Lan Chen Todd Warstler Jennifer Yeung Jim Elkins Jon Braeutigam Robert Brackenbury Peter Woodford Woody Tyler Travis Haney Greg Parker Giles Feldpausch Ann Storberg Marge McPhee Annette Russell Todd Warstler Patrick Moraniec Janet Sudac Lori Barrett
Treasurer Khouri called the meeting to order at 9:30 am.
Opening Remarks: Brief discussion by Chair Treasurer Khouri explaining that this is his last meeting as he will be retiring at the end of this month. He wished the State of Michigan Retirement System continued success.
Approval of the November 27, 2018 SMIB Special Meeting Minutes – Motion to approve: Reginald Sanders. Seconded: Dina Richard. The vote was unanimous to approve.
AGENDA
Executive Summary Jon Braeutigam, Chief Investment Officer for the Bureau of Investments, discussed the plans returns over the past one, three, five, seven, and ten years. For each time period the plan had higher returns than the peer median. He believes that market returns will be lower going forward, and this view is shared by industry consultants in general.
Asset Allocation Review, Markets Review and Outlook Gregory Parker, Director of Investments - Public Markets for the Bureau of Investments discussed that quality decision making is the foundation to obtain the returns that SMRS has experienced. He also discussed the overwhelming consensus view of lower returns going forward.
1 Review of Investment Reports – Public
Woody Tyler, Senior Investment Manager of Defined Contribution, Trusts & Agencies presented a brief overview of the defined contribution plan noting that a more comprehensive look at defined contribution will ensue at the March meeting.
Daniel Quigley, Senior Investment Manager of the Fixed Income Division discussed that the fixed income portfolio outperformed its benchmark and peer group across all time periods.
Jack Behar, Senior Investment Manager of the Domestic Equity Division explained that they had a very strong year and experienced excellent performance on the growth side of the portfolio.
Patrick Moraniec, Senior Investment Manager of the International Equity Division stated that the portfolio slightly outperformed the benchmark over the last twelve months. This was driven by developed market exposure.
Review of Investment Reports – Private
Peter Woodford, Senior Investment Manager of Private Equity explained that returns have been strong relative to peer median returns, ranking in the top 7% of peers over the past ten years. The outperformance to peers is attributed to fund selectivity and strategy.
Jennifer Yeung, Senior Investment Manager of Real, Opportunistic, & Absolute Return explained that the division experienced a 6% return for the year with outperformance of the benchmark in the third quarter. This outperformance was driven by overweight exposure to credit strategies as well as manager selection.
Todd Warstler, Senior Investment Manager of Real Estate & Infrastructure stated that outperformance relative to the one-year benchmark resulted from the divisions strategy. No big changes in this strategy are anticipated at this time.
Public Comment Treasurer Khouri asked that any attendees wishing to address the Board come forward. No public comment.
Treasurer Khouri adjourned the meeting at 11:02 am. Motion to adjourn by Dina Richard. Seconded: Reginald Sanders. The vote was unanimous to adjourn.
Approved:
______Rachael Eubanks, Chairman
2 State of Michigan Retirement System EXECUTIVE SUMMARY State of Michigan Investment Board Meeting March 7, 2019
Gregory J. Parker, CFA Director of Investments – Public Markets Director of Asset Allocation Bureau of Investments EXECUTIVE SUMMARY December 2018
Performance Great peer comparison. MPSERS Plan (12/31/18) 1-Year 3-Years 5-Years 7-Years 10-Years Annualized Returns 2.7% 8.6% 8.0% 9.8% 9.6% Policy Returns 1.7% 9.1% 7.7% 10.0% 10.3% Peer Median Returns* -2.1% 6.7% 5.6% 8.2% 8.5% *State Street Universe greater than $10 billion.
Over the past one, three, five, seven, and ten years, the returns are significantly higher than peer median returns. Compared to the State Street Universe of public pension plans greater than $10 billion, the returns are mostly within the top decile of returns. Also, over this time period, the plans’ returns were among the least risky, as measured by standard deviation.
The ten-year return includes the impact of the global financial crisis. Over a very long horizon, since 1979, the annualized rate of return on the plan assets has been approximately 9.3%.
Compounding at higher than peer returns can add significant value. For example, based on the $44.5 billion December 2008 market value, a ten-year annualized return of 9.6% compared to the 8.5% peer median return would add about $11 billion in excess value. Due to these gains, it is estimated that General Fund and School Aid Fund 2018 fiscal year annual contributions into pension fund pools are nearly $780 million less than they would have been if SMRS had earned the peer average investment return.
The returns beat the policy benchmark over the past year by 1.0%. Many of the asset classes posted results in excess of their performance benchmarks; selectivity in real return & opportunistic, real estate, domestic equity, absolute return and fixed income all were significant drivers of excess return.
For the year ending December 2018, returns exceeded the peer median return by 4.8%, earning the highest return in the State Street peer universe. Most of the individual asset class returns were better than median over this time-period, and Fixed Income and Real Estate returned the highest in their respective peer universes as well.
Asset Allocation A low return environment.
Given the low rates of return available in the capital markets for safe assets, and in order to earn the actuarial rates of returns, additional risks (primarily equity risk) must be assumed.
Liquidity is another fundamental risk assumed and it is managed through asset allocation. The plans have outstanding capital commitments to fund approximately $12.4 billion in illiquid assets, primarily in private equity. In the December 2018 quarter, over $1.5 billion of new commitments were made.
The combined systems paid out approximately $2.0 billion net of contributions over the past twelve months ending in December 2018. Over the past year, real return & opportunistic was a net purchaser of approximately $760 million, fixed income of $125 million, and both private equity and absolute return were around $100 million. Over the past year in round numbers, the allocation to domestic equity was reduced by $770 million and real estate by $720 million. The allocation to short-term cash decreased by approximately $1.5 billion.
1
Capital Markets Risk assets in focus.
Capital market assumptions used for determining strategic asset allocations are being reduced across the board, and especially for safer, publicly traded fixed income securities. This is the general opinion for most consultants, investment banks, and other market participants. The reason for this phenomenon is the low interest rate environment caused by the policies of the Federal Reserve and other central banks, as well as the run-up in prices for most risk assets over the past several years since the depths of the Great Recession.
Private real estate was the best performing asset class for 2018, returning approximately 6.7%. Publicly traded REITs fell in value by -4.1% including dividend returns.
Fundamentals supporting domestic equities are still strong. Year-over-year growth in analyst estimated earnings for the next year are close to 12%. Since June 2007, the growth style has returned over 50% more than value style. Perhaps even more surprising, since December 2000 growth and value have earned nearly the same return.
Defined as a pullback of 20% or more on the closing value of the S&P 500, the U.S. equity market has not hit a correction since the Global Financial Crisis.
In 2018, both credit spreads and long-term interest rates increased making it difficult for bond managers to earn extra return. With the yield curve at its flattest levels since the summer of 2007 and credit spreads at fairly normal levels, securitized credit and floating rate assets are attractive alternatives.
The most recent reading of the annualized U.S. GDP growth was 3.4%, slightly below the consensus estimate of 3.5%. Current estimates for 2019 GDP growth for the U.S. is around 2.5%. Coincidental economic indicators such as the Institute for Supply Management’s Manufacturing and Non-Manufacturing PMI Indexes are well above 50, indicating that the U.S. economy is likely to continue to grow.
2 Investment Update
Highlighting the quarter.
($ Millions)
NEW COMMITMENTS
September 30 – December 31, 2018
Asset class Fund Name / (Managed By) Commitment
Private Equity TSG 8, L.P. (TSG Consumer Partners) $150 Warburg Pincus Global Growth, L.P. (Warburg Pincus Global Growth GP, LP) 150 KKR European Fund V (USD) SCSp (KKR Associates Europe V SCSp) 125 Greenspring Master G, L.P. (Greenspring Associates, Inc.) 100 Flagship Pioneering Special Opportunities Fund II, L.P. (Flagship Opp. Fund II GP, LLC) 100 FS Equity Partners VIII, L.P. (FS Capital Partners VIII, LLC) 75 5AM Opportunities I, L.P. (5AM Partners VI, LLC) 30 Greenspring Micro II, L.P. (Greenspring Associates, Inc.) 25 5AM Ventures VI, L.P. (5AM Partners VI, LLC) 20
Real Estate and Infrastructure Division Blackstone Real Estate Partners IX, LP (Blackstone Real Estate Advisors) 200 Lone Star Fund XI, LP (Lone Star) 200
Real, Opportunistic, & Absolute Return Division TSSP Capital Solutions Fund I, L.P. (TSSP Capital Solutions Management I, LLC) 300 Flywheel Energy Co-Invest, LLC (Kayne Anderson) 35
TOTAL $1,510
3 State of Michigan Retirement System PERFORMANCE State of Michigan Investment Board Meeting March 7, 2019
Jon M. Braeutigam Chief Investment Officer Bureau of Investments Bureau of Investments Mission Statement
The Bureau of Investments continually strives to provide quality investment management services, broad professional expertise, and independent advice to the State of Michigan Investment Board as fiduciary of the State of Michigan Retirement System, and independent of the Board, to the State Treasurer for various Michigan trust funds and the State’s common cash, for which the State Treasurer is the fiduciary.
SMRS Goals
Maintain sufficient liquidity to pay benefits.
Meet or exceed the actuarial assumption over the long term.
Perform in the top half of the public plan universe over the long term.
Diversify assets to reduce risk.
Exceed individual asset class benchmarks over the long term.
1 MPSERS PENSION Time-Weighted Rates of Return Periods Ending December 31, 2018
% of Ten Seven Five Three One Current Portfolio Years 1 Years 1 Years 1 Years 1 Year Quarter 12/31/18 Rate Rank Rate Rank Rate Rank Rate Rank Rate Rank Rate Rank
TOTAL PLAN 100.0 9.6 9 9.8 5 8.0 4 8.6 13 2.7 5 -4.2 15 2 Median - Greater than $10 Billion 8.5 8.2 5.6 6.7 -2.1 -5.9 MPSERS Total Plan Policy 10.3 10.0 7.7 9.1 1.7 -3.9 DOMESTIC EQUITIES 22.6 13.3 30 12.9 18 8.3 22 9.5 18 -3.8 17 -15.0 86 Median 2 13.0 12.4 7.6 8.3 -5.9 -13.5 S&P 1500 Index 13.2 12.6 8.3 9.2 -5.0 -14.0
INTERNATIONAL EQUITIES 15.9 7.5 53 6.1 57 2.0 32 4.8 23 -14.3 54 -11.7 29 Median 2 7.6 6.3 1.3 4.1 -14.2 -12.1 International Blended Benchmark 3 5.8 5.0 0.7 4.5 -14.2 -11.5
PRIVATE EQUITIES 18.0 13.5 7 14.9 10 14.6 14 14.8 11 18.2 7 3.9 12 Median 2 8.9 10.3 9.3 9.5 7.7 1.0 4
2 Alternative Blended Benchmark 19.1 20.1 17.2 20.7 21.4 8.5
BONDS 12.8 5.2 29 3.5 20 3.9 14 4.1 19 1.2 4 0.8 41 Median 2 4.4 2.6 2.7 2.5 -0.3 0.7 Barclays Aggregate 3.5 2.1 2.5 2.1 0.0 1.6
REAL ESTATE & INFRASTRUCTURE 10.1 5.6 51 11.5 27 12.0 21 10.4 29 12.2 4 2.3 23 Median 2 5.7 10.2 10.5 8.7 8.9 1.6 NCREIF - Property Blended Index 5 6.1 8.3 7.9 5.8 5.4 1.1 NCREIF Open Fund Index Net 6.0 10.0 9.4 7.3 7.4 1.5
REAL RETURN AND OPPORTUNISTIC 11.5 11.5 13.6 12.4 19.5 6.6 50% (CPI +500 bps) + 50% (6.8% actuarial rate) 7.3 7.2 7.5 7.3 1.2
ABSOLUTE RETURN 6.2 6.1 5.7 4.0 4.4 4.3 0.2 HFRI FOF Cons 1 month lagged 2.9 3.0 2.1 1.8 0.6 -2.0 CASH EQUIVALENTS 2.8 0.8 0.8 1.0 1.4 2.2 0.6 1 Month T-Bill 0.3 0.4 0.6 0.9 1.8 0.6
1 Annualized Returns and Percentile Rank. 2 Comparison universe is the State Street Universe comprised of Public Funds greater than $10 billion on the total plan level and greater than $1 billion for asset classes. 3 International blended benchmark is S&P Developed BMI-EPAC 50/50 prior to 1/1/10. S&P Developed BMI-EPAC 75 USD / 25 Local, 1/1/10 to 9/30/10. MSCI ACWI ex USA Gross 10/1/10 to present. 4 SP 500 + 300 bps thru 12/31/06. Ending market value (EMV) weighted blend of 10 yr yield + 300 bps and SP 500 + 300 bps 12/31/06 to 9/30/09. EMV weighted blend of 10 yr yield + 300 bps and SP 500 + 300 bps 3-month lagged 9/30/09 to present. 5 NCREIF - Property Blended Index is NPI minus 75 bps prior to October 2005, NPI minus 130 bps current. Source: State Street Analytics; the NCREIF - NPI (Property Index) source is NCREIF; the S&P BMI-EPAC Index source is S&P. 1 Year Ending December 31, 2018 Total Fund Attribution
Total Michigan vs. Total Fund Benchmark Total Fund Performance Total Value Added:1.0%
Total Value Added 1.0% Asset Allocation -0.5 %
Total Fund Benchmark 1.7% Manager Value Added 1.5%
Total Fund 2.7% Other 0.0% 3 0.0% 0.9% 1.8% 2.7% 3.6% 4.5% -2.0 % -1.0 % 0.0% 1.0% 2.0% 3.0%
Total Asset Allocation:-0.5 % Total Manager Value Added:1.5%
Total Domestic Equity -2.9 % 0.1% 0.3%
Total International Equity 1.8% -0.3 % -0.1 %
Total Fixed Income 1.7% 0.0% 0.1%
Total Absolute Return -0.2 % 0.0% -0.1 %
Total Short Term 1.1% -0.1 % 0.0% Weight Weight (%) Total Private Equity -2.0 % -0.3 % -0.5 %
Total Real Estate and Infrastructure 0.9% 0.0% 0.7%
Total Real Return and Opportunistic -0.4 % 0.0% 1.0%
-6.0 % -3.0 % 0.0% 3.0% 6.0% -0.6 % -0.3 % 0.0% 0.3% 0.6% -1.6 % -0.8 % 0.0% 0.8% 1.6%
Average Active Weight Asset Allocation Value Added Manager Value Added Cumulative and Consecutive Total Fund Returns
MPSERS Cumulative For Years Ending 12/31/18
1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year MPSERS 2.7 9.2 8.6 7.2 8.0 9.3 9.8 9.0 9.4 9.6 Public Plan - Median (> $10 billion)* -2.1 6.3 6.7 5.2 5.6 7.2 8.2 7.2 7.8 8.5 Rank 55139445559 bp Difference - Median 478 294 190 198 234 210 158 175 156 113 Consecutive For Years Ending
12/18 12/17 12/16 12/15 12/14 12/13 12/12 12/11 12/10 12/09 MPSERS 2.7 16.2 7.4 2.8 11.3 16.4 12.6 3.3 12.7 12.1 Public Plan - Median (> $10 billion)* -2.1 15.3 7.9 0.4 7.1 15.7 13.2 1.7 12.7 17.4 Rank 5 39684 5 3765125380 4 bp Difference - Median 478 86 -45 238 421 73 -53 165 -4 -530
MSERS Cumulative For Years Ending 12/31/2018
1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year MSERS 2.7 9.3 8.7 7.2 8.0 9.3 9.8 8.9 9.3 9.6 Public Plan - Median (> $1 billion)* -2.9 6.3 6.7 5.1 5.3 7.2 8.0 7.1 7.88.5 Rank 43863444420 bp Difference - Median 562 299 195 202 263 216 176 187 151 110 Consecutive For Years Ending
12/18 12/17 12/16 12/15 12/14 12/13 12/12 12/11 12/10 12/09 MSERS 2.7 16.2 7.5 2.8 11.3 16.3 12.6 3.2 12.5 11.9 Public Plan - Median (> $1 billion)* -2.9 15.0 7.9 0.3 6.9 15.9 13.0 1.3 12.9 18.4 Rank 4 35632 3 4466156185 bp Difference - Median 562 117 -39 249 440 40 -45 189 -36 -648
*State Street Public Funds Universe Cumulative and Consecutive Total Fund Returns
MSPRS Cumulative For Years Ending 12/31/18
1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year MSPRS 2.7 9.3 8.6 7.2 8.0 9.3 9.7 8.9 9.3 9.5 Public Plan - Median (> $1 billion)* -2.9 6.3 6.7 5.1 5.3 7.2 8.0 7.1 7.88.5 Rank 43864444420 bp Difference - Median 561 299 194 201 262 213 172 186 151 106 Consecutive For Years Ending
12/18 12/17 12/16 12/15 12/14 12/13 12/12 12/11 12/10 12/09 MSPRS 2.7 16.2 7.5 2.8 11.3 16.2 12.5 3.3 12.6 11.5 Public Plan - Median (> $1 billion)* -2.9 15.0 7.9 0.3 6.9 15.9 13.0 1.3 12.9 18.4
5 Rank 4 35643 3 4469136088 bp Difference - Median 561 117 -42 248 436 32 -52 204 -29 -686
MJRS Cumulative For Years Ending 12/31/18
1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year MJRS 2.7 9.3 8.7 7.2 7.9 9.2 9.6 8.8 9.2 9.2 Public Plan - Median (> $1 billion)* -2.9 6.3 6.7 5.1 5.3 7.2 8.0 7.1 7.88.5 Rank 43864455625 bp Difference - Median 558 301 196 202 258 201 162 173 136 76 Consecutive For Years Ending
12/18 12/17 12/16 12/15 12/14 12/13 12/12 12/11 12/10 12/09 MJRS 2.7 16.3 7.4 2.8 11.0 15.6 12.5 3.1 12.2 9.9 Public Plan - Median (> $1 billion)* -2.9 15.0 7.9 0.3 6.9 15.9 13.0 1.3 12.9 18.4 Rank 4 33653 3 5370156990 bp Difference - Median 558 126 -43 248 413 -25 -56 178 -66 -847
*State Street Public Funds Universe State of Michigan Retirement System ASSET ALLOCATION REVIEW State of Michigan Investment Board Meeting March 7, 2019
Jon M. Braeutigam Chief Investment Officer Bureau of Investments STATE OF MICHIGAN RETIREMENT SYSTEM PROFILE - DECEMBER 2018
Asset Allocation Market Value* 12/31/18 (Billions of Dollars) Absolute Short Term $80 Return 2.8% $69.9 $69.5 6.2% $70 $60.7 $60.1 $62.2 Real Estate & Domestic Equity $60 $56.6 Infrastructure 22.6% $49.7 $51.0 10.1% $47.1 $48.1 $50 $44.5
Real Return & $40 Opportunistic 11.5% $30 Private Equity 18.0% $20 Fixed Income $10 12.8% International Equity $0 16.0%
1 Asset Allocation By Market Value (In Millions)
Investment Strategies 12/31/2018 12/31/2017 Market Value By Plan ~ 12/31/18 Domestic Equity $15,693 22.6% $17,051 24.4% (in Millions) Private Equity 12,540 18.0% 10,629 15.2% Pension Plan OPEB** Combined International Equity 11,084 16.0% 12,990 18.6% Mkt. Value Mkt. Value Mkt. Value % Fixed Income 8,894 12.8% 8,675 12.4% Real Return & Opport. 8,017 11.5% 6,103 8.7% MPSERS $47,472 $6,022 $53,494 76.9% Real Estate & Infra. 7,045 10.1% 6,964 10.0% MSERS - (closed) 11,675 2,475 14,150 20.4% Absolute Return 4,280 6.2% 4,002 5.7% MSPRS 1,412 185 1,597 2.3% Short Term*** 1,943 2.8% 3,520 5.0% MJRS - (closed) 254 1 255 0.4% TOTAL $69,496 100.0% $69,934 100.0% TOTAL $60,813 $8,683 $69,496 100.0%
MSERS includes the Military Pension Fund
Short Term Equivalents (in Billions) Short Term Strategy*** $1.9 18th Largest DB Public Pension Fund in the U.S. Short Term in Other Inv. Strategies 0.6 TOTAL SHORT TERM $2.5 3.6% of Total Funds Pensions & Investments Survey - February 4, 2019 issue
*The combined net payout for the plans for FY 2017 was $2.2 billion with $24.2 billion paid out since FY 2008 thru FY 2017 (SOMCAFR). This represents the amount paid to beneficiaries in excess of employer and employee contributions. **OPEB - Other Post Employment Benefits Sources and Uses of Cash January 2018 ~ December 2018
1/01/18 Balance of Short-Term Cash: $ 3,521 12/31/18 Balance of Short-Term Cash: 1,943 Net Short-Term Cash Decrease: $ 1,578
$769 $723
$0 2 -$62 -$109 -$103
-$764
Absolute Domestic Fixed Real Return & Return Equity Income Opportunistic -$2,032
Private International Real Estate & Net Benefit Equity Equity Infrastructure Payments
A negative number in an asset category indicates a use of cash, a positive number indicates a source of cash. Dollars in millions Asset Allocation Targets As of 12/31/18
MPSERS MSERS MSPRS MJRS SMRS
Asset Class 12/31/18 Target* 12/31/18 Target* 12/31/18 Target* 12/31/18 Target* Ranges
Domestic Equity 22.6% 28.0% 22.6% 28.0% 22.6% 28.0% 22.6% 28.0% 20% - 35%
Private Equity 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 10% - 20%
3 International Equity 15.9% 16.0% 15.9% 16.0% 15.9% 16.0% 15.9% 16.0% 15% - 25%
Long Term Fixed 12.8% 10.5% 12.8% 10.5% 12.8% 10.5% 12.8% 10.5% 10% - 20% Income
Real Estate & 10.1% 10.0% 10.1% 10.0% 10.1% 10.0% 10.1% 10.0% 5% - 15% Infrastructure
Real Return & 11.5% 9.5% 11.5% 9.5% 11.5% 9.5% 11.5% 9.5% 5% - 15% Opportunistic
Absolute Return 6.2% 6.0% 6.2% 6.0% 6.2% 6.0% 6.2% 6.0% 3% - 9%
Short Term Fixed 2.8% 2.0% 2.8% 2.0% 2.8% 2.0% 2.8% 2.0% 1% - 6% Income
TOTAL 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
*Complies with basket clause and international restrictions. State of Michigan Retirement System MARKETS REVIEW AND OUTLOOK State of Michigan Investment Board Meeting March 7, 2019
Gregory J. Parker, CFA Director of Investments – Public Markets Director of Asset Allocation Bureau of Investments CAPITAL MARKETS
Return and Risk Assumptions, Benchmark and Outlook A starting point.
Assumed Trailing Return* 10-Year Standard Deviation* MPSERS Plan (Arithmetic) (Benchmark**) Private Equity 11.8% 24.0% 19.1% International Equity 9.9% 20.0% 6.6% Domestic Equity 8.3% 17.0% 13.2% Real Estate (Core) 6.5% 11.5% 6.1% Absolute Return 6.1% 9.0% 0.4% Real Ret/Opportunistic 9.6% 9.5% 6.4% Long-Term Fixed Income 3.5% 4.0% 3.5% Short-Term 2.8% 1.0% 0.3%
* Aon Hewitt Investment Consultants 2019 Long-Term Return/Risk Assumptions ** Investment Policy Statement; Annualized Returns *** Actual investments may differ due to changing conditions and the availability of new information
Overview A market update. Capital market assumptions used for determining strategic asset allocations are being reduced across the board, and especially for safer, publicly traded fixed income securities. This is the general opinion for most consultants, investment banks, and other market participants. The reason for this phenomenon is the low interest rate environment caused by the policies of the Federal Reserve and other central banks, as well as the run-up in prices for most risk assets over the past several years. Since June 2007, the growth style has returned over 50% more than value style. Perhaps even more surprising, since December 2000, growth and value have earned nearly the same return. Given the fact that the broad international equity index MSCI ACWI ex USA returned -14.2% for the year ending December 2018, it is not surprising that higher quality foreign companies outperformed on average by 1.6%. Over the past ten, twenty, and thirty years, publicly traded REITs have out-returned private real estate by 5.5%, 1.4%, and 2.8% annualized respectively, though they are three times more volatile. Having lost value to other currencies in 2017, as measured by the DXY Index the U.S. dollar strengthened in 2018 by 4.5%. The most recent reading of the annualized U.S. GDP growth was 3.4%, slightly below the consensus estimate of 3.5%. Current estimates for 2019 GDP growth for the U.S. are around 2.5%. Coincidental economic indicators such as the Institute for Supply Management’s Manufacturing and Non-Manufacturing PMI Indexes are well above 50, indicating that the U.S. economy is likely to continue to grow.
1 International Equity A compelling case.
International equities continue to underperform domestic equities. Over the year ending December 2018, the international market index, MSCI ACWI ex USA, underperformed the S&P 1500 index by -9.2%. Over the past three, five, seven, and ten years, international underperformed domestic by -4.7%, -7.6%, -7.7, and -6.6% annualized, respectively.
Based on a forward estimated price-to-earnings valuation multiple, developed international markets trade at approximately a 20% discount to U.S. counterparts while emerging markets are at a 25% discount.
Year-over-year earnings growth for international markets is estimated to be roughly 9.8% for the year. Earnings in international markets can grow around 30% just to get back to all-time highs, suggesting that there could be a runway for earnings to grow at a high rate for some time. Trading at a valuation multiple discount, international equity represents a leveraged play on continued global growth.
Within international equities, emerging markets underperformed developed markets last year by -0.5%. Over the past three and five years, emerging beat developed by 6.1% and 1.3% annualized, respectively. The plan is overweight emerging markets, with a weight of 30.8% compared to the benchmark weight of 25.7%.
Given the fact that the broad international equity index MSCI ACWI ex USA returned -14.2% for the year ending December 2018, it is not surprising that higher quality foreign companies outperformed on average by 1.6%.
The plan is underweight international equity against a global benchmark (approximately 41% versus 45% of total public equity) though at a higher allocation than the peer median allocation; 16.0% versus peer median of 14.6%.
Domestic Equity High earnings growth.
The broad U.S. stock market return for the one year ending December 2018 was -4.4%. Small caps have underperformed larger caps over the past decade. Over the past one, three, five, seven, and ten years, small caps have underperformed large caps by -6.6%, -1.9%, -4.1%, -2.3% and -1.2% annualized, respectively.
Meanwhile, growth extended its dominance over value stocks in the U.S., having outperformed by 8.5%, 3.3%, 4.2%, 2.8% and 3.5% annualized over the past one, three, five, seven and ten years, respectively. Since June 2007, the growth style has returned over 50% more than value style. Perhaps even more surprising, since December 2000, growth and value have earned nearly the same return.
Analysts are estimating year-over-year growth in earnings for the next year to be nearly 12%, which is about half the rate of the trailing twelve months, but almost twice as fast as the cumulative average growth rate of the past 40 years.
Many valuation metrics are near historical averages. However, the absolute returns over the next cycle may not be as strong as the historical average of 11 – 12% year-over-year total returns. One reason for this is the fact that market EPS is above trend as is returns on equity. However, the largest securities in the market today are less cyclical (economically sensitive) as past market leaders.
2 Interest Rates The Fed on pause?
At the end of December 2018, the U.S. 10-year Treasury was yielding only 17 basis points more than the 2-year Treasury. That is the narrowest spread between the two rates since June 2007 and the dawning of the global financial crisis.
Flat yield curves are often viewed as worrisome. One material difference between the environment of today’s flat yield curve and the one in 2007 is the fact that the current Fed Fund’s rate is accommodative by historical standards, yielding a real yield of close to 0.5% while in the summer of 2007 the real yield was close to 2.5%.
At its December 2018 meeting, the Federal Reserve Board voted to raise its key interest rate by an additional 25 basis points, the ninth of this tightening cycle. At the beginning of 2019, the market has priced in very low odds of a tenth tightening, and in fact is now saying that there is a slight chance of a Fed cut in late 2019.
Spreads on investment-grade fixed income are just slightly above its average level of 1.1%. Spreads on riskier high-yield assets are slightly tighter at around 30 basis points below average. The plan has reduced its credit exposure and has instead allocated towards securitized assets which now represent 36.0% of the fixed income portfolio. Over the past year ending December 2018, the Structured Fixed Income portfolio returned 3.2% while the benchmark Aggregate index was essentially flat.
Real Estate REIT market adjustment.
Over the one year ending December 2018, the REIT market, as measured by the NAREIT index, fell -4.1% including its dividend yield.
Dividend yields on REITs are around 3.9% which is 1.25% higher than the yield of the ten-year U.S. Treasury and at its historical average spread.
Although investing in similar assets, the returns of publicly traded REITs (measured by NAREIT) and private real estate (measured by the NCREIF-ODCE Index), have historically been lowly (and at times are anti) correlated to one another. Over the past ten, twenty, and thirty years, publicly traded REITs have out-returned private real estate by 5.5%, 1.4%, and 2.8% annualized, respectively, though they are three times more volatile.
Commodities Falling prices.
Over the past ten years, commodities prices broadly have been falling, as measured by the Thomson Reuters CRB Commodity Index, down more than 60% from the peak in 2008 and, since their lows in 2016, prices are up less than 10%.
The price for crude oil has decreased over the past year ending December 2018, down 25% year-over-year to approximately $45.40 per barrel.
Having lost value to other currencies in 2017, as measured by the DXY Index the U.S. dollar strengthened in 2018 by 4.5%.
3 Annual Total Returns of Key Asset Classes 1999 - 2018
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Best Int'l Gov't Corp. Gov't Int'l Int'l Real Int'l Int'l Gov't Int'l U.S. Real Int'l U.S. U.S. Real U.S. Int'l Real Best Equity Bonds Bonds Bonds Equity Equity Estate Equity Equity Bonds Equity Equity Estate Equity Equity Equity Estate Equity Equity Estate
26.97% 13.23% 10.40% 11.50% 40.82% 20.90% 20.06% 26.65% 16.65% 12.38% 41.44% 16.38% 14.26% 16.83% 32.80% 13.08% 13.32% 11.93% 27.19% 6.71% U.S. Real Real Corp. U.S. Real Int'l Real Real Cash U.S. Real Gov't U.S. Int'l Real U.S. Real U.S. Infla- Equity Estate Estate Bonds Equity Estate Equity Estate Estate Equity Estate Bonds Equity Equity Estate Equity Estate Equity tion
20.27% 12.24% 7.28% 10.52% 29.58% 14.48% 16.62% 16.59% 15.84% 2.05% 27.24% 13.11% 9.02% 16.17% 15.29% 11.81% 1.01% 7.97% 21.13% 1.91% Hedge Corp. Gov't Real Hedge U.S. U.S. U.S. Gov't Infla- Corp. Int'l Corp. Real Real Corp. Gov't Corp. Real Cash Funds Bonds Bonds Estate Funds Equity Equity Equity Bonds tion Bonds Equity Bonds Estate Estate Bonds Bonds Bonds Estate
18.93% 9.40% 7.24% 6.74% 9.01% 11.78% 5.65% 15.34% 8.67% 0.10% 16.05% 11.15% 8.35% 10.54% 10.99% 7.53% 0.86% 5.63% 6.96% 1.88% Real Cash Cash Hedge Real Hedge Hedge Hedge Hedge Corp. Hedge Corp. Infla- Corp. Hedge Gov't Infla- Int'l Corp. Gov't Estate Funds Estate Funds Funds Funds Funds Bonds Funds Bonds tion Bonds Funds Bonds tion Equity Bonds Bonds
11.36% 6.16% 4.43% 3.57% 8.99% 5.83% 5.13% 9.21% 7.68% -3.07% 9.65% 8.46% 2.96% 9.37% 7.70% 4.92% 0.66% 4.50% 6.42% 0.88% Cash Hedge Hedge Infla- Corp. Corp. Infla- Cash U.S. Real Infla- Gov't U.S. Hedge Infla- Hedge Hedge Infla- Hedge Hedge
4 Funds Funds tion Bonds Bonds tion Equity Estate tion Bonds Equity Funds tion Funds Funds tion Funds Funds
4.83% 5.77% 3.11% 2.39% 7.69% 5.25% 3.42% 4.81% 5.47% -6.46% 2.72% 5.52% 1.75% 4.22% 1.49% 3.14% 0.37% 2.09% 3.88% -1.05% Infla- Infla- Infla- Cash Gov't Gov't Cash Corp. Corp. Hedge Cash Hedge Cash Gov't Cash Infla- Cash Hedge Gov't Corp. tion tion tion Bonds Bonds Bonds Bonds Funds Funds Bonds tion Funds Bonds Bonds
2.68% 3.39% 1.55% 1.79% 2.36% 3.48% 3.06% 4.27% 5.10% -19.86% 0.19% 5.07% 0.10% 2.02% 0.07% 0.68% 0.01% 1.89% 2.30% -2.51% Corp. U.S. U.S. Int'l Infla- Infla- Gov't Gov't Cash U.S. Gov't Infla- Hedge Infla- Corp. Cash Corp. Gov't Infla- U.S. Bonds Equity Equity Equity tion tion Bonds Bonds Equity Bonds tion Funds tion Bonds Bonds Bonds tion Equity
-1.94% -6.98% -10.64% -14.95% 1.88% 3.25% 2.65% 3.46% 5.03% -36.72% -2.19% 1.50% -3.55% 1.70% -2.01% 0.04% -0.77% 1.05% 2.12% -4.96% Gov't Int'l Int'l U.S. Cash Cash Corp. Infla- Infla- Int'l Real Cash Int'l Cash Gov't Int'l Int'l Cash Cash Int'l Bonds Equity Equity Equity Bonds tion tion Equity Estate Equity Bonds Equity Equity Equity
Worst -2.25% -15.31% -19.74% -21.30% 1.16% 1.33% 1.95% 2.55% 4.06% -45.52% -16.86% 0.13% -13.71% 0.11% -2.60% -3.87% -5.67% 0.27% 0.84% -14.20% Worst
Annualized Returns 1999 - 2018 Cash Infl. Hedge Gov't. Corp. Int'l. US Eq. R.E. Return 1.90% 2.17% 3.73% 4.12% 5.24% 4.64% 5.99% 8.97% Return Risk 1.01% 1.34% 5.14% 4.46% 5.18% 18.85% 16.06% 4.55% Risk
- Hedge Funds are represented by the HFRI FOF Conservative Index - U.S. Equity is represented by the S&P 1500 - Inflation is represented by the U.S. Consumer Price Index - Real Estate is represented by the NPI - International Equity is represented by the MSCI - AC World EX-USA Index - Corporate Bonds are represented by the Barclays Capital - Credit Index - Cash is represented by 30-day T-Bills - Government Bonds are represented by the Barclays Capital U.S. Government State of Michigan Retirement System DEFINED CONTRIBUTION REVIEW State of Michigan Investment Board Meeting March 7, 2019
Woodrow S. Tyler Senior Investment Manager Defined Contribution, Trusts & Agencies Division EXECUTIVE SUMMARY
Overview
The State of Michigan’s Defined Contribution (DC) plan has over 177,590 participants across four constituent bases as shown below. The State’s DC program initially started as a supplemental retirement plan, but for many of the plans it is now participants’ primary retirement vehicle.
DC plans are participant led investments. The role of the Bureau of Investments is to offer a sufficient range of investment options to allow the Participants to diversify their individual retirement accounts and construct portfolios that reasonably span the risk/return spectrum. To this end, the Plans may be comprised of at least one investment option from the categories below.
SOM Plans Number of Combined 401k & 457 (12-31-18) Participants State Employees 74,611 $6,979 School Employees 101,326 585 Judges 686 253 State Police 968 23 Total 177,591 $7,841 ($ in millions)
Investments Options
Tier I: Target Date Funds and Passively Managed Index Funds Target Date Funds (TDFs) are the default option for plan participants. Each TDF seeks to achieve its objective by investing in a set of underlying index funds representing various asset classes. Over time, the allocation to asset classes and funds change according to a predetermined "glide path" and will become more conservative as it approaches the target retirement date. Passively Managed Index Funds are comprised of low-cost index funds which seek to replicate the performance of a variety of cash, bond and stock indices with very little tracking error and at a low fee. Tier II: Actively Managed Funds These are funds actively managed by investment managers in an attempt to outperform various cash, bond and stock indices over long periods of time. Tier III: Self Directed Brokerage Account – Non-Core Options TD Ameritrade provides access to a broad range of investment choices including individual stocks, bonds, CDs, over 100 commission-free ETFs, and more than 13,000 mutual funds—including more than 2,100 no-load, no-transaction-fee (NTF) mutual funds.
1 Investment Selection
The selection of each investment option for the Plans is to be based on the prudence standards set by the Governing Documents and applicable law, with flexibility built-in to allow a search to take full advantage of strategic opportunities. The search will focus on finding opportunities which are tailored to the Plans’ specific needs. The BOI, in consultation with the Office of Retirement Services (ORS), will establish search criteria that aligns with the purpose and objective an investment option is seeking to attain. Due diligence will be completed with the goal of selecting a plan that, in the totality of circumstances, offers fair and reasonable investment options for the Plan participants.
With respect to Tier III investments, the universe of available options is extensive. Since the selection of investments is directed solely by the Participants which elect the Tier III option, the State does not provide any criteria for selecting or monitoring these non-core investment options. Investment Monitoring
The ORS and the BOI may examine each investment option as circumstances require, to ensure that a particular investment option’s investment style and other relevant investment criteria, such as performance, fee and expense levels or the occurrence of a significant change are acceptable, given the purpose of each investment option. Market Environment and Outlook
Structural changes in the U.S. retirement system are supporting growth in the DC industry: o Rapid decline of employer funded pensions o Potential erosion of Social Security benefits o Workforce aging o New regulations, specifically, the Pension Protection Act of 2006; . Automatically enroll employees into the DC plan . Establish safe harbor investments known as QDIA
In an effort to simplify the investment process for participants, industry trend has been to reduce the number of investment options offered in a DC plan. Based on the recent CEM benchmark report, the average number of investments offered by similarly sized plans is 13 options. The State of Michigan currently offers 20 investment options. The desired outcome of streamlining would be to benefit from economies of scale and ease the burden of asset allocation at the participant level.
Another trend in the industry is the focus on retirement income. As fewer individuals have access to pension plans and DC plans have become the primary retirement vehicle for many Americans, more plan sponsors are exploring the ability to generate sustainable income in retirement.
2 Target Date Funds
The Pension Protection Act of 2006 established safe harbor investments known as Qualified Default Investment Alternative (QDIA). To qualify as a QDIA, the investment must offer; “a mix of investments which take into account the individual’s age or retirement date.” Target Date Funds (TDFs) are an example of this.
Over time, the allocation to asset classes and funds change according to a predetermined "glide path" and will become more conservative as it approaches the target retirement date.
The allocations in the glide path are not due to tactical decisions to overweight or underweight a particular asset class based on its market outlook.
Because index funds are used, each Fund attempts to closely match the characteristics and returns of its custom benchmark as opposed to any attempts to outperform this benchmark.
Return vs Beta 2015 ‐ 2018 12.0
10.0 TDF 2035 TDF 2040 8.0 TDF 2030 TDF 2020 TDF 2025 TDF 2015 6.0 TDF 2045
Return % TDF 2050 4.0 TDF 2055 Ret. Income TDF 2060 2.0
0.0 0 0.2 0.4 0.6 0.8 1 1.2 1.4 Beta
3 Index Funds Tier I is comprised of low-cost funds which seek to replicate the performance of a variety of bond and stock market indices.
Return vs Beta 2015 ‐ 2018 12.0
S&P 500 Index 10.0 Emerging Markets Fund
8.0 S&P Midcap 6.0 Return % 4.0 SSgA Bond Fund Global Equities Fund
2.0 Short Term Investments 0.0 0 0.2 0.4 0.6 0.8 1 1.2 1.4 Beta
Actively Managed Funds Tier II is comprised of actively managed funds which attempt to outperform various bond and stock indices.
Return vs Beta 2015 ‐ 2018 Jennison Large Cap Growth 12.0
10.0 Virtus Small Cap Value Dodge & T. Rowe Price Mid Cap Cox 8.0 Value
6.0 Prudential High Yield Artisan Mid‐Cap PIMCO Total Return Growth Return % 4.0 Oakmark Voya 2.0 Small Cap Growth Stable Value American Funds EuroPacific Growth 0.0 0 0.2 0.4 0.6 0.8 1 1.2 1.4 Beta
Non-Core Options Tier III is a Self Directed Brokerage Account.
4 Plan Awards and Recognitions 2014-2018 2018 2018 Signature Award ORS tied for third place in the Retirement Readiness category of the 2018 Signature Awards, presented by the Plan Sponsor Council of America (PSCA) during its 71st annual National Conference in Scottsdale, Arizona. The Signature Award recognizes excellence in retirement plan communications to both plan sponsors and plan participants. ORS and Voya Financial received the award for the Women's Guide to Retirement. The guide was developed after focus group and survey results showed that women had significant concerns about retirement. The 16-page guide breaks planning for retirement down into achievable steps and provides web and phone resources. Two NAGDCA Leadership Awards ORS received two 2017 Leadership Recognition Awards through the National Association of Government Defined Contribution Administrators (NAGDCA). These awards recognize DC plans for their outstanding achievements. The Road to Retirement campaign won the award for outstanding achievement in Technology and Social Media. The Small Steps campaign won the award for outstanding achievement in Plan Design. 2016 State of Michigan and Voya Financial® win Plan Sponsor Council of America (PSCA) Signature Award For the second consecutive year, ORS received a Signature Award from PSCA. The Nearing Retirement Guide from The State of Michigan and Voya® took second place in PSCA's Plan Publications for Participants category. The guide is handed out during ORS's Pre-Retirement Orientations and at Voya's Get Ready to Retire seminars. 2015 ORS and Voya share Eddy Award ORS won second place as the plan sponsor in the Special Projects category for public plans at the Eddy Awards. The Eddy Award is the annual recognition by Pensions & Investments (P&I) of best practices by defined contribution plans in providing investment education to participants. Voya Financial™, which designed the award-winning campaign, shares the award with ORS. The winning entry was the “Mix It Up” campaign, designed to give state employee 401(k) participants a simple way to improve their investment mix. ORS recognized with two industry awards NAGDCA, the National Association of Government Defined Contribution Administrators, Inc., selected ORS to receive two 2014 Leadership Awards. The first award was in the Effective Communication/Participant Education category, while the second award was in the Plan Design category. Plan design covers how the DC plan functions – what features are offered to plan participants, investment portfolio options, loan or withdrawal provisions, and other aspects covering how the DC plan work.
2014 NAGDCA Award ORS has been chosen as a recipient of the 2013 Leadership Recognition Award through the National Association of Government Defined Contribution Administrators' (NAGDCA). This award recognizes defined contribution plans for outstanding achievements in Participant Education and Effective Communication. Only the top five projects in each category receive a Leadership Award, and this is the third year in a row ORS has been recognized. Best in Show Award The State of Michigan 401(k) & 457 Plans have won a Best in Show award from the Insurance and Financial Communicators Association. Chosen from 650 submissions, the award recognizes the creativity, design, and writing in the State of Michigan Match Campaign. Plan Sponsor Award ORS was awarded as a finalist for the 2014 PLAN SPONSOR Plan Sponsor of the Year award in the Public DC category for our 457 Plan. The finalists were featured in the March 2014 issue of PLANSPONSOR Magazine.
5 SMRS Defined Contribution Strategies 12/31/18
% of Fee per Markets Amount Total Total $1,000 QDIA ($ in Millions)
Target Date Fund $1,477 $0.70
Total Target Date $1,477 18.8% $0.70
Tier I Index Funds
State Street S&P 500 Index Fund $1,046 $0.23 State Street Bond Market Index Fund 716 0.52 State Street Global All Cap Equity ex-US Index Fund 518 1.21 State Street S&P Mid Cap Index Fund 501 0.52 BlackRock S&P Small Cap 600 Equity Index CL F 125 0.30 BlackRock Government Short-Term Investment CL F 227 0.60 BlackRock Emerging Markets Index CL F 112 0.70
Total Tier I Index $3,243 41.4% $0.54
Tier II Active Funds
Stable Value Fund $1,156 $2.30 Dodge & Cox Stock Fund 525 4.10 Jennison Large Cap Growth Fund 344 2.90 American Funds EuroPacific Growth R6 293 4.90 Voya Small Cap Growth Equity Fund 131 4.30 PIMCO Total Return I Fund 111 5.50 T. Rowe Price Mid-Cap Value Fund 108 6.40 Oakmark Equity & Income I Fund 107 4.30 Artisan Mid Cap Fund 88 7.30 Virtus Ceredex Small-Cap Value Eq I 67 6.80 Prudential High Yield Fund 25 3.80
Total Tier II Active $2,955 37.7% $3.64
Tier III
Self Directed Brokerage Account $166 NA
Total SDBA $166 2.1% NA
Total Defined Contribution Assets $7,841 100.0% $1.73
6 SMRS Defined Contribution by Investment Strategy 12/31/18
Self Managed Account 2.1%
Target Date Retirement Fund 18.8%
Passive Strategies 41.4%
Active Strategies 37.7%
Market Value in Millions
12/31/18 12/31/17 Passive Strategies $3,243 41.4% $4,548 55.2% Active Strategies 2,955 37.7% 2,123 25.8% Target Date Retirement Fund 1,477 18.8% 1,382 16.8% Self Managed Account 166 2.1% 184 2.2% Total Investments $7,841 100.0% $8,237 100.0%
*Loan Fund $192M as of 12/31/18
7 Defined Contribution Performance by Fund 12/31/18
Fund Name Market Value 1-Year 3-Years 5-Years 10-Years
State Street Target Retirement Income Fund $36,495,096 -2.8% 3.7% 2.7% 5.6% State Street Income Custom Index -2.8% 3.7% 2.7% 5.8% Morningstar Target-Date Retirement -3.2% 3.4% 2.5% 5.7% Variance State Street Income Custom Index 0.0% 0.0% 0.0% -0.2% Variance Morningstar Target-Date Retirement 0.4% 0.2% 0.1% -0.1%
State Street Target Retirement 2015 Fund 51,679,117 -3.1% 4.4% 3.3% 7.5% State Street 2015 Custom Index -3.2% 4.3% 3.3% 7.6% Morningstar Target-Date 2015 -3.9% 4.3% 3.2% 6.9% Variance State Street 2015 Custom Index 0.0% 0.0% 0.0% -0.1% Variance Morningstar Target-Date 2015 0.8% 0.1% 0.2% 0.6%
State Street Target Retirement 2020 Fund 122,746,583 -4.5% 5.2% 3.9%8.5% State Street 2020 Custom Index -4.5% 5.1% 3.9% 8.5% Morningstar Target-Date 2020 -4.6% 4.4% 3.2% 7.3% Variance State Street 2020 Custom Index 0.0% 0.1% 0.0% 0.0% Variance Morningstar Target-Date 2020 0.1% 0.8% 0.6% 1.1%
State Street Target Retirement 2025 Fund 151,640,528 -5.9% 5.8% 4.3%9.1% State Street 2025 Custom Index -5.9% 5.8% 4.3% 9.2% Morningstar Target-Date 2025 -5.4% 5.0% 3.7% 8.3% Variance State Street 2025 Custom Index 0.0% 0.0% 0.0% -0.1% Variance Morningstar Target-Date 2025 -0.5% 0.8% 0.7% 0.8%
State Street Target Retirement 2030 Fund 165,505,713 -6.7% 6.1% 4.5%9.6% State Street 2030 Custom Index -6.7% 6.0% 4.5% 9.7% Morningstar Target-Date 2030 -6.3% 5.4% 3.8% 8.6% Variance State Street 2030 Custom Index 0.0% 0.0% 0.0% -0.1% Variance Morningstar Target-Date 2030 -0.4% 0.7% 0.6% 1.1%
State Street Target Retirement 2035 Fund 176,168,615 -7.3% 6.3% 4.6% 9.9% State Street 2035 Custom Index -7.3% 6.3% 4.6% 10.0% Morningstar Target-Date 2035 -7.1% 5.8% 4.1% 9.2% Variance State Street 2035 Custom Index 0.0% 0.1% 0.0% -0.1% Variance Morningstar Target-Date 2035 -0.3% 0.5% 0.5% 0.7%
State Street Target Retirement 2040 Fund 169,494,516 -7.9% 6.6% 4.7% 10.0% State Street 2040 Custom Index -7.9% 6.5% 4.7% 10.1% Morningstar Target-Date 2040 -7.8% 5.9% 4.2% 9.3% Variance State Street 2040 Custom Index 0.0% 0.1% 0.0% -0.1% Variance Morningstar Target-Date 2040 -0.1% 0.7% 0.5% 0.8%
State Street Target Retirement 2045 Fund 169,012,014 -8.4% 6.7% 4.7% 10.1% State Street 2045 Custom Index -8.5% 6.6% 4.7% 10.1% Morningstar Target-Date 2045 -8.1% 6.1% 4.3% 9.6% Variance State Street 2045 Custom Index 0.0% 0.1% 0.0% -0.1% Variance Morningstar Target-Date 2045 -0.3% 0.6% 0.4% 0.4%
State Street Target Retirement 2050 Fund 207,969,361 -8.6% 6.7% 4.7% 10.1% State Street 2050 Custom Index -8.6% 6.6% 4.7% 10.1% Morningstar Target-Date 2050 -8.4% 6.1% 4.3% 9.5% Variance State Street 2050 Custom Index 0.0% 0.1% 0.0% -0.1% Variance Morningstar Target-Date 2050 -0.1% 0.6% 0.4% 0.5%
State Street Target Retirement 2055 Fund 189,330,185 -8.6% 6.7% 4.7%N/A State Street 2055 Custom Index -8.6% 6.6% 4.7% N/A Morningstar Target-Date 2055 -8.4% 6.2% 4.4% N/A Variance State Street 2055 Custom Index 0.0% 0.1% 0.0% N/A Variance Morningstar Target-Date 2055 -0.1% 0.5% 0.3% N/A
8 Fund Name Market Value 1-Year 3-Years 5-Years 10-Years
State Street Target Retirement 2060 Fund $37,126,336 -8.5% 6.7% N/A N/A State Street 2060 Custom Index -8.6% 6.6% N/A N/A Morningstar Target-Date 2060+ -8.5% 6.2% N/A N/A Variance State Street 2060 Custom Index 0.0% 0.1% N/A N/A Variance Morningstar Target-Date 2060+ 0.0% 0.5% N/A N/A TIER I
State Street S&P 500 Index Fund 1,045,641,904 -4.4% 9.2% 8.5% 13.1% S&P 500 Index -4.4% 9.3% 8.5% 13.1% Morningstar Large Blend -6.2% 7.5% 6.3% 11.4% Variance S&P 500 Index 0.0% 0.0% 0.0% 0.0% Variance Morningstar Large Blend 1.8% 1.7% 2.2% 1.6%
State Street Bond Market Index Fund 715,603,370 0.0% 2.0% 2.5% 3.4% Bloomberg Barclays U.S. Aggregate Index 0.0% 2.1% 2.5% 3.5% Morningstar Intermediate-Term Bond -0.5% 2.1% 2.2% 4.3% Variance Bloomberg Barclays U.S. Aggregate Index 0.0% -0.1% 0.0% -0.1% Variance Morningstar Intermediate-Term Bond 0.5% -0.1% 0.2% -0.9%
State Street Global All Cap Equity ex-U.S. Index Fund 517,884,681 -14.6% 4.8% 1.0% N/A MSCI ACWI ex USA IMI (Net) -14.8% 4.4% 0.9% N/A Morningstar Foreign Large Blend -14.6% 2.5% 0.1% N/A Variance MSCI ACWI ex USA IMI (Net) 0.2% 0.4% 0.2% N/A Variance Morningstar Foreign Large Blend 0.0% 2.3% 0.9% N/A
State Street S&P Mid Cap Index Fund 501,266,011 -11.1% 7.6% 6.0% 13.6% S&P 400 Index -11.1% 7.7% 6.0% 13.7% Morningstar Mid-Cap Blend -11.3% 5.3% 3.8% 11.7% Variance S&P 400 Index 0.0% 0.0% -0.1% -0.1% Variance Morningstar Mid-Cap Blend 0.2% 2.3% 2.2% 1.9%
BlackRock Government Short-Term Investment CL F 226,745,077 1.8% 1.0% 0.6% N/A BofA Merill Lynch US 3-Month Treasury Bill Index 1.9% 1.0% 0.6% N/A Variance BofA Merill Lynch US 3-Month Treasury Bill Index 0.0% 0.0% 0.0% N/A
BlackRock S&P Small Cap 600 Equity Index CL F 124,519,131 -8.5% N/AN/AN/A Russell 2000 Index -11.0% N/A N/A N/A Morningstar Small Blend -12.7% N/A N/A N/A Variance Russell 2000 Index 2.5% N/A N/A N/A Variance Morningstar Small Blend 4.2% N/A N/A N/A
BlackRock Emerging Markets Index CL F 111,538,819 -14.6% 9.4% 1.6%N/A MSCI Emerging Market (Net) -14.6% 9.3% 1.7% N/A Morningstar Diversified Emerging Mkts -16.1% 6.9% 0.4% N/A Variance MSCI Emerging Market (Net) 0.0% 0.2% -0.1% N/A Variance Morningstar Diversified Emerging Mkts 1.5% 2.5% 1.1% N/A TIER II
Stable Value Fund 1,155,620,948 2.1% 2.1% 2.1% 2.2% Barclays Int Gov/Credit A or Higher Index 1.2% 1.4% 1.7% 2.4% Hueler Universe 2.2% 2.0% 1.9% 2.2% Variance Barclays Int. Gov Credit A or Better Index 0.9% 0.7% 0.5% -0.2% Variance Hueler Universe -0.2% 0.1% 0.3% 0.0%
Dodge & Cox Stock Fund 525,248,803 -7.6% 9.9% 7.0% 13.1% Russell 1000 Value Index -8.3% 7.0% 6.0% 11.2% Morningstar Large Value -8.6% 6.7% 5.1% 10.5% Variance Russell 1000 Value Index 0.7% 2.9% 1.0% 1.9% Variance Morningstar Large Value 1.0% 3.1% 1.8% 2.7%
9 Fund Name Market Value 1-Year 3-Years 5-Years 10-Years
Jennison Large Cap Growth Fund $344,316,131 0.2% 11.5% N/A N/A Russell 1000 Growth Index -1.5% 11.2% N/A N/A Morningstar Large Growth -2.2% 8.9% N/A N/A Variance Russell 1000 Growth Index 1.7% 0.3% N/A N/A Variance Morningstar Large Growth 2.4% 2.6% N/A N/A
American Funds EuroPacific Growth R6 292,594,522 -14.9% 4.1% 1.9% 7.7% MSCI EAFE Index - Net Div -13.8% 2.9% 0.5% 6.3% Morningstar Foreign Large Blend -14.6% 2.5% 0.1% 5.8% Variance MSCI EAFE Index - Net Div -1.1% 1.2% 1.3% 1.4% Variance Morningstar Foreign Large Blend -0.3% 1.5% 1.7% 1.8%
Voya Small Cap Growth Equity Fund 131,176,290 -15.4% 4.7% 3.9% N/A Russell 2000 Growth Index -9.3% 7.2% 5.1% N/A Morningstar Small Growth -6.0% 8.3% 4.9% N/A Variance Russell 2000 Growth Index -6.1% -2.6% -1.3% N/A Variance Morningstar Small Growth -9.5% -3.7% -1.1% N/A
PIMCO Total Return I Fund 110,482,561 -0.3% 2.5% 2.6% 4.7% Bloomberg Barclays U.S. Aggregate Index 0.0% 2.1% 2.5% 3.5% Morningstar Intermediate-Term Bond -0.5% 2.1% 2.2% 4.3% Variance Bloomberg Barclays U.S. Aggregate Index -0.3% 0.4% 0.0% 1.2% Variance Morningstar Intermediate-Term Bond 0.3% 0.3% 0.3% 0.4%
T. Rowe Price Mid-Cap Value Fund 108,437,988 -10.4% 7.7% 6.0% 13.1% Russell Midcap Value Index -12.3% 6.1% 5.4% 13.0% Morningstar Mid-Cap Value -12.9% 5.2% 3.8% 11.5% Variance Russell Midcap Value Index 1.9% 1.6% 0.6% 0.1% Variance Morningstar Mid-Cap Value 2.4% 2.5% 2.2% 1.6%
Oakmark Equity & Income I Fund 107,168,884 -8.0% 5.6% 3.9% 8.0% 60% S&P 500/40% Barclays U.S. Gov/Credit Index -2.5% 6.6% 6.2% 9.4% Morningstar Allocation--50% to 70% Equity -5.9% 4.6% 3.5% 7.8% Variance 60% S&P 500/40% Barclays U.S. Gov/Credit Index -5.5% -1.0% -2.4% -1.4% Variance Morningstar Allocation--50% to 70% Equity -2.1% 1.0% 0.4% 0.2%
Artisan Mid Cap Fund 87,916,458 -3.2% 5.3% 4.9% 15.0% Russell Midcap Growth Index -4.8% 8.6% 7.4% 15.1% Morningstar Mid-Cap Growth -6.6% 7.1% 5.4% 12.7% Variance Russell Midcap Growth Index 1.5% -3.3% -2.5% -0.1% Variance Morningstar Mid-Cap Growth 3.4% -1.8% -0.5% 2.2%
Virtus Ceredex Small-Cap Value Eq I 66,581,171 -12.0% 8.2% 4.2% 12.6% Russell 2000 Value Index -12.9% 7.4% 3.6% 10.4% Morningstar Small Value -15.4% 5.1% 2.2% 10.7% Variance Russell 2000 Value Index 0.9% 0.8% 0.6% 2.2% Variance Morningstar Small Value 3.4% 3.1% 2.0% 1.9%
Prudential High Yield Fund 25,107,398 -1.3% 5.9% N/A N/A Bloomberg Barclays U.S. Corp. HY 1% Issuer Cap Index -2.2% 7.2% N/A N/A Morningstar High Yield Bond -2.8% 5.4% N/A N/A Variance Bloomberg Barclays U.S. Corp. HY 1% Issuer Cap Index 0.9% -1.3% N/A N/A Variance Morningstar High Yield Bond 1.5% 0.6% N/A N/A TIER III
Self Directed 165,646,585
TOTAL $7,840,664,797
Loan Fund: $192,085,265
10 State of Michigan Retirement System FIXED INCOME REVIEW State of Michigan Investment Board Meeting March 7, 2019
Daniel J. Quigley Senior Investment Man ager Fixed Income Division EXECUTIVE SUMMARY
Performance
MPSERS Plan (12/31/18) 1-Year 3-Years 5-Years 7-Years 10-Years Annualized Returns 1.2% 4.1% 3.9% 3.5% 5.2% Bloomberg Barclays US Agg 0.0% 2.1% 2.5% 2.1% 3.5% Peer Median Returns -0.3% 2.5% 2.7% 2.6% 4.4% Percentile Rank vs. Peers* 4 19 14 20 29 *State Street Universe greater than $1 billion
The fixed income portfolio outperformed its benchmark and peer group across all time periods. This year-over-year (YOY) outperformance was due to an overweight to securitized assets as ABS and MBS outperformed U.S. Treasuries and Corporate Bonds during the year. Security selection has also contributed to outperformance within the corporate bond portfolio.
The duration positioning of the portfolio helped the annual performance due to an overweight to floating-rate securities in a rising short-term interest rate environment. An underweight to long duration securities also assisted performance as short and intermediate duration securities outperformed longer maturity bonds due to interest rate increases.
Investment Grade and High Yield Credit experienced negative performance for the year. This was primarily driven by a market selloff in the fourth quarter of 2018. Investment Grade returned -2.5% and High Yield returned -2.1% for the year. The Structured Fixed Income portion of the portfolio provided an offset to this negative performance as it returned 3.2% on a YOY basis.
Strategy Update
The goal of the Long-Term Fixed Income Division portfolio is to meet or exceed the returns of the Bloomberg Barclays U.S. Aggregate Bond Index while satisfying the overall characteristics of a core fixed income portfolio. These characteristics are: income, liquidity, principal preservation, and diversification from equity market risk. The portfolio has a higher yield than the benchmark without having meaningfully more risk than the U.S. Aggregate Index. The yield-to-maturity of the portfolio is currently 4.3% versus a benchmark yield of 3.3%. In addition to this, the portfolio has an equity beta of 0.0, in line with the U.S. Aggregate Index.
The Core-plus strategy implemented to achieve this goal includes:
o Core: As of December 31, 2018, the allocation to U.S. Treasuries, investment-grade corporate bonds, government-guaranteed U.S. Agency Debentures, RMBS, and Commercial Mortgage Backed Securities (CMBS) was 70.1%. This includes a 24.3% allocation to U.S. Treasuries, TIPS, and cash.
o Plus: The portfolio maintains a strategic, out-of-benchmark allocation to high-yield corporate debt, securitized credit, and global fixed income strategies as market opportunities allow. This allocation increases the portfolio yield and total return potential, but will result in lower liquidity and higher volatility. The allocation to the Plus portfolio was 29.9% as of December 31, 2018.
1 Tactical Update
The allocation to securitized credit, primarily in CMBS, ABS, non-agency RMBS, and CLO securities, was 20.9% of the portfolio at the end of the quarter. The combination of low interest rate duration and high coupon income (often floating rate) is attractive at this point in the interest rate cycle.
The allocation to high-yield strategies was 5.3% at the end of the quarter, at the low end of its range over recent years. Reducing this allocation benefitted the portfolio as credit spreads widened during the quarter, causing corporate bonds to underperform.
The portfolio has an increased allocation to floating rate securities, including AAA CLO investments and investment-grade floating rate corporate bonds. This allocation accounts for approximately 20% of portfolio assets and should position the portfolio to outperform in a rising interest rate environment.
The allocation to U.S. TIPS increased during the quarter to 4.3% of the fixed income portfolio. The TIPS allocation underperformed nominal U.S. Treasuries by roughly 200 bps on a YOY basis. We believe that this allocation has the potential to outperform nominal U.S. Treasuries going forward due to the fact that current inflation expectations are lower than the long-term inflation target of the Federal Reserve.
Market Environment and Outlook
The yield curve for U.S. Treasury securities flattened for the year with short-term interest rates increasing by more than long-term rates. The yield on the thirty-year Treasury increased by 28 bps on a YOY basis to 3.02% while two-year Treasury yields increased by 60 bps to 2.49%. The two-year trend of rising interest rates experienced a reversal in recent months as investors bid up the price of U.S. Treasuries during the fourth quarter sell-off. The yield on the ten-year U.S. Treasury decreased by 38 bp during the quarter while the yield on the two-year Treasury declined by 33 bp. The markets currently expect the FOMC to take a pause on their monetary tightening campaign due to lower economic growth expectations.
Inflation expectations declined during the quarter with ten-year breakeven inflation expectations ending December at 1.8%. This was a 30 bp decline in expectations on a quarter-over-quarter basis. The portfolio has slightly increased its allocation to U.S. TIPS and believes that owning these securities offers value should inflation indices rebound.
Credit markets underperformed with high-yield spreads ending December at 526 bps. This represented a 210 bp increase in spreads for the quarter. These spread levels are roughly 90 bp wider than their five-year average. Investment grade credit spreads widened by 47 bp for the quarter to 153 bp, roughly 25 bp wider than the 125 bp five-year average.
Global markets also experienced a sell-off with the Emerging Markets Debt (EMD) Index returning -0.18% for the quarter. This still represented roughly 400 bp of outperformance vs U.S. High Yield Credit as EMD continued to recover on a relative basis from a sell-off earlier in the year. EMD had a return of -2.46% on a one-year basis and EM spreads ended the year at 343 bp.
Securitized assets such as CMBS and CLO bonds also experienced spread widening during the recent market correction. The overall spread movement was more muted than the widening in corporate credit. Spreads on BBB CMBS securities ended the quarter at 301 bps, 49 bp wider for the quarter. Spreads have decreased by 29 bp on a YOY basis.
2
Developed market interest rates declined across most major markets during the quarter as investors increased their weighting in safe-haven government bonds. The yield on the ten-year German Bund ended the year at 0.2%, down 23 bp for the quarter. The Japanese JGB ended the year with a ten-year yield of -0.01%. Italian sovereign debt also had strong performance during the quarter after selling off earlier in the year. The Italian ten-year bond’s spread to German Bunds tightened by 17 bp during the quarter and ended the year with a yield of 2.7%.
Conclusion
The portfolio remains defensively positioned for rising interest rates. The duration remains short of the benchmark and the portfolio maintains an underweight to long-term debt. This position is offset through a larger allocation to structured and corporate debt securities which increase the income of the portfolio. The portfolio will continue to look for attractive risk-adjusted opportunities within the fixed income opportunity set.
3 SMRS Long-Term Fixed Income by Strategy 12/31/18
Amount Total % of Total
Core ($ in Millions)
LTFID Internal $4,990 PIMCO Mortgage Fund 252 Dodge & Cox 243 PGIM Investment Grade Credit 228 Total Core $5,713 64.2%
Tactical
Pyramis $298 Loomis Core Plus 226 Total Tactical $524 5.9%
Securitized Debt
Met West Securitized Ops $462 Principal CMBS 393 Napier Park CLO Debt 258 TICP CLO Debt 254 Napier Park ABS Income 407 Napier Park Strategic Loan 83 Total Securitized Debt $1,856 20.9%
High Yield
Columbia Management $244 PGIM High Yield 210 Crescent Direct Lending 18 Total High Yield $472 5.3%
Global
T. Rowe Global Multi-Sector $228 PGIM Global Liquid Relative Value 101 Total Global $329 3.7%
TOTAL $8,894 100.0%
NOTE: Totals may not be exact due to rounding.
4 SMRS Fixed Income Holdings Portfolio Characteristics Benchmark: Barclays Aggregate
12/31/18
Characteristic Portfolio Benchmark Average Maturity (Yrs) 7.5 8.2 Duration (Yrs) 4.7 5.9 Spread Duration (Yrs) 5.6 6.0 Coupon (%) 3.7 3.2 Yield to Maturity (%) 4.3 3.3 Credit Rating A AA VaR (%) 3.6 4.2 Tracking Error 1.27 NA Beta (vs S&P 500) 0.02 -0.04
Commentary Objectives Highlights Income: The coupon of the portfolio is approximately 50 bps higher than the benchmark. Roughly 20% of the portfolio is invested in floating-rate securities, allowing coupon income to increase relative to the benchmark if the yield curve continues to flatten. Liquidity: 24.3% of the portfolio is invested in cash, U.S. Treasuries, and TIPS. These investments can be liquidated via same- day trading. Principal Preservation: The portfolio has a large allocation to U.S. Treasuries and carries an investment-grade credit rating. Diversification: The equity beta of the portfolio is roughly 0.0 meaning that the portfolio returns are uncorrelated with equity market movements, and in line with the benchmark bond index.
5 SMRS Fixed Income By Rating 12/31/18
Not Rated AA 1.1% 5.5%
Below Investment Grade 10.5%
A AAA 16.6% 48.2%
BBB 18.1%
Market Value in Millions 12/31/18
Assets Percent Benchmark Difference
AAA $4,292 48.2% 71.6% -23.4% AA 488 5.5% 3.3% 2.2% A 1,476 16.6% 10.1% 6.5% BBB 1,606 18.1% 12.5% 5.6% Not Rated 100 1.1% 1.9% -0.8% * Below Investment Grade 932 10.5% 0.6% 9.9%
Total Investments $8,894 100.0% 100.0%
* Comprised of approximately 7.7% High Yield Credit and 2.8% High Yield RMBS/ABS Benchmark: Barclays US Aggregate
6 SMRS Fixed Income By Asset Type 12/31/18
Unassigned Cash Government 1.2% 2.2% Related 2.7% U.S. TIPS 4.3%
Securitized 36.0% U.S. Treasuries 17.7%
Corporate 35.9%
Market Value in Millions 12/31/18
Assets Percent Benchmark Difference
Securitized $3,198 36.0% 30.7% 5.3% Corporate 3,196 35.9% 24.6% 11.3% U.S. Treasuries 1,576 17.7% 38.6% -20.9% U.S. TIPS 380 4.3% 0.0% 4.3% Government Related 239 2.7% 6.1% -3.4% Unassigned 110 1.2% 0.0% 1.2% Cash 195 2.2% 0.0% 2.2%
Total Investments $8,894 100.0% 100.0%
Benchmark: Barclays US Aggregate
7 SMRS Duration Distribution Fixed Income Composite Versus Benchmark 12/31/18
40% Portfolio % Benchmark
31.1% 30%
23.8% 22.6% 19.9% 20.3% 20% 16.8% 16.1% 16.2% 14.4%
10% 7.2% 5.8% 4.9%
0.9% 0.0% 0% <1 1 to 3 3 to 5 5 to 7 7 to 10 >10 NA
# of Years Source: Factset Market Value in Millions Portfolio Benchmark Portfolio Benchmark Duration Assets Weight Weight Duration* Duration* <1 $1,494 16.8% 0.9% 0.1 1.0 1 to 3 1,428 16.1% 23.8% 1.8 2.0 3 to 5 1,768 19.9% 31.1% 4.1 4.1 5 to 7 1,808 20.3% 22.6% 5.9 5.7 7 to 10 1,440 16.2% 7.2% 8.0 7.8 >10 435 4.9% 14.4% 17.4 15.5 NA 521 5.8% 0.0% 0.0 0.0 Total $8,894 100.0% 100.0% 4.6 5.8
* Effective Duration Benchmark: Barclays US Aggregate
8 SMRS Internal/External Manager Performance – Net of Fees
12/31/18 Total Fixed Income Performance, Net of Fees (MPSERS)
Market Value 1‐Year 3‐Years 5‐Years 7‐Years 10‐Years Total Fixed Income $8,893,868,844 1.04% 3.93% 3.73% 3.36% 5.03% Bloomberg/Barclays Aggregate Bond Index N/A 0.01% 2.06% 2.52% 2.10% 3.48%
Internal Core Fixed Income $4,990,060,787 0.95% 3.23% 3.47% 2.91% 4.56%
Externally Managed Core Fixed Income $495,096,139 0.62% 3.38% 3.04% 3.00% 4.76% Dodge & Cox Core 242,622,267 0.37% 3.35% 3.13% 3.40% 5.02% PIMCO Mortgage Fund 252,473,872 0.86% Bloomberg/Barclays Aggregate Bond Index N/A 0.01% 2.06% 2.52% 2.10% 3.48% Investment Grade Credit $227,983,352 ‐2.50% 3.58% 3.53% 3.78% 6.29% PGIM Investment Grade 227,983,352 ‐2.50% 3.58% 3.53% 3.89% 6.38% Bloomberg/Barclays Credit Index N/A ‐2.11% 3.16% 3.22% 3.30% 5.52% Tactical Fixed Income $523,677,442 ‐0.50% 3.52% 3.43% Loomis Sayles CorePlus 225,777,186 ‐0.53% 3.96% 3.01% N/A N/A Fidelity Tactical Bond Fund 297,900,256 ‐0.55% 5.12% N/A N/A N/A Bloomberg/Barclays Aggregate Bond Index N/A 0.01% 2.06% 2.52% 2.10% 3.48% High Yield Fixed Income $471,681,824 ‐2.52% 5.40% 3.97% N/A N/A Columbia Management High Yield 244,098,334 ‐3.06% 4.92% 3.83% N/A N/A PGIM High Yield 209,948,654 ‐1.88% 6.02% 4.14% N/A N/A Crescent Direct Lending 17,634,836 N/A N/A N/A N/A N/A Bloomberg/Barclays US HY BA/B 2% Cap N/A ‐1.88% 6.18% 3.79% Structured Fixed Income $1,856,416,606 3.23% N/A N/A N/A N/A Principal CMBS 392,966,565 3.68% 4.50% 4.82% 8.18% 17.61% MetWest Securitized Opportunities 461,841,078 2.89% 4.73% 3.71% N/A N/A Napier Park ABS Income 406,811,189 7.24% 10.28% N/A N/A N/A Napier Park Strategic Loan LP 83,209,498 7.95% N/A N/A N/A N/A Napier Park CLO Debt 257,841,002 0.90% N/A N/A N/A N/A TICP CLO Debt 253,747,273 ‐0.09% N/A N/A N/A N/A Bloomberg/Barclays Aggregate Bond Index N/A 0.01% 2.06% 2.52% 2.10% 3.48% Blended CMBS Benchmark N/A 1.01% 3.21% 4.24% 4.21% 9.29% Global Fixed Income $328,952,694 0.18% N/A N/A N/A N/A T. Rowe Global Multi‐Sector 227,812,693 ‐0.24% N/A N/A N/A N/A PGIM GLRV 101,140,000 1.14% N/A N/A N/A N/A Custom GMS Benchmark N/A 0.34% N/A N/A N/A
9 State of Michigan Retirement System REAL, OPPORTUNISTIC, & ABSOLUTE RETURN REVIEW State of Michigan Investment Board Meeting March 7, 2019
Jennifer Yeung Senior Investment Manager Real, Opportunistic, & Absolute Return Division EXECUTIVE SUMMARY
Performance
MPSERS Plan (12/31/18) 1-Year 3-Years 5-Years 7-Years 10-Years Absolute Return 4.3% 4.4% 4.0% 5.7% 6.1% HFRI FOF Conservative 0.6% 1.8% 2.1% 3.0% 2.9%
The value of the Absolute Return portfolio is $4.3 billion with a one-year return of 4.3% and 0.2% for the current quarter. Exposure to diversifying and credit strategies as well as manager selection helped to mitigate broad negative performance in the market.
Performance from diversifying managers contributed positive returns during the fourth quarter. Outperformance in this sector was largely driven by quantitative strategies. These gains were partially offset by losses from managers that had short U.S. Fixed Income strategies.
During the quarter, credit strategies outperformed on a relative basis versus both credit indices as well as broader markets. Structured credit and residential mortgage managers protected capital and, in some cases, contributed positive returns during the quarter.
Strategy Update
The objective of the Absolute Return portfolio is to diversify the total plans’ holdings, targeting returns above investment-grade fixed income with lower volatility than the equity portfolio. The portfolio utilizes a diverse mix of managers that invest both long and short to target specific exposures and seek to hedge out unwanted risk.
No new commitments for the quarter.
We remain cautious on directional risks and have continued to shift towards diversifying strategies. We have been increasing allocations to special situations and co- investments, which have more idiosyncratic risk and are implemented on a market neutral basis. We also believe that allocations to opportunities in macro and quantitative strategies could be well positioned to take advantage of a rising interest rate and higher volatility environment. Higher interest rates may have caused recent equity market losses due to general risk off behavior, but we do not believe this is a direct risk of the Absolute Return program. The portfolio has low direct correlation and sensitivity to an upward movement in interest rates.
Overall, we will continue to focus on opportunities that seek to provide diversification, protect the downside and deliver absolute return.
1 Performance
MPSERS Plan (12/31/18) 1-Year 3-Years 5-Years 7-Years 10-Years Real Return and Opport. 19.5% 12.4% 13.6% 11.5% N/A Custom Benchmark 7.3% 7.5% 7.2% 7.3% N/A
Total Real Return and Opportunistic portfolio value is $8.0 billion with a total one-year return of 19.5%. Performance for the year was driven by strong income from private credit, natural resource strategies, and media and entertainment holdings, as well as capital appreciation of transportation and media and entertainment assets.
Strategy Update
The objective of the Real Return & Opportunistic portfolio is to provide an inflation hedge and/or to gain exposure to attractive opportunities that may not fit in another plan portfolio.
The Real Return & Opportunistic portfolio has approximately $3.5 billion of unfunded commitments. New commitments closed during the quarter include:
o $300 million to TSSP Capital Solutions, L.P, a commingled fund that will provide structured credit and equity financing solutions to late-stage growth companies.
o $35 million to Flywheel Energy LLC, an energy company that owns and operates natural gas assets and midstream systems in the U.S.
We remain focused on finding differentiated strategies that are additive to the current portfolio mix.
o We continue to like private energy opportunities, niche strategies with some scalability, and contractual cash flow.
o Also, we like opportunities in the opportunistic credit space. These strategies have defensible cash flows, are backed by high quality collateral and offer structural downside protection. We continue to be selective and favor investment teams that are disciplined and have experience investing over multiple cycles.
2 SMRS Real, Opportunistic, & Absolute Return 12/31/18
Cash/Other 1.0%
Real Return & Absolute Return Opportunistic 34.6% 64.4%
Market Value in Millions
12/31/18 12/31/17
Real Return & Opportunistic $7,917 64.4% $6,028 59.7% Absolute Return 4,254 34.6% 3,992 39.5% Cash/Other 126 1.0% 85 0.8% Total Investments $12,297 100.0% $10,105 100.0%
3 SMRS Absolute Return 12/31/18
Net Market Values by Entity
Net Market Value
Drawbridge Opportunities Fund $ 241,926,741
* EnTrust White Pine Partners, LP 38,895,784 JM IV, LP 73,934,114 MP Securitized Credit Master Fund, LP 78,413,778 Riverside Credit Solutions Fund I, LP 3,378,680 SJC Direct Lending Revolver Fund III, LP 38,766,956
* Tahquamenon Fund, LP 3,778,517,313 Visium Balanced Fund, LP 299,800 Total Absolute Return $ 4,254,133,166 Short-Term Investments & Other 25,750,734
Grand Total $ 4,279,883,900
4 SMRS Absolute Return 12/31/18
Investments By Strategy
Diversifying 14.9%
Credit 32.4%
Equity 21.0%
Multi-Strategy / Event 31.7%
Strategy Breakdown
Underlying Funds: 79 Median Position Size: 0.5%
Strategies: 4 Average Position Size: 1.3%
Relationships: 8 Largest Position Size: 6.3%
5 SMRS Absolute Return 12/31/18
Liquidity Analysis
Redeemable Marginal Allocation Aggregate Allocation (% each period) (% since Analysis Date) By 4/1/19 36.9% 36.9% By 7/1/19 23.2.% 60.1% By 1/1/20 13.0% 73.1% By 7/1/20 5.3% 78.4% By 7/1/21 6.0% 84.4% After 7/1/21 9.6% 94.0% Illiquid 6.0% 100.0% Total 100.0% N/A
Monthly % Period 100% 84.4% 90% 78.4% 80% 73.1% 70% 60.1% 60% 50% 36.9% 40% 30% 20% 10% 0% Jan2019 Mar2019 May2019 Jul2019 Sep2019 2019 Nov Jan2020 Mar2020 May2020 Jul2020 Sep2020 2020 Nov Jan2021 Mar2021 May2021 Jul2021 Sep2021 2021 Nov Jan2022 Mar2022 May2022 Jul2022 Sep2022 2022 Nov Jan2023 Mar2023 May2023 Jul2023 Sep2023 2023 Nov Jan2024 Mar2024 May2024 Jul2024 Sep2024
6 SMRS Real Return and Opportunistic 12/31/18 Net Market Value by Entity
Unfunded Net Market Value Commitment
* Abernathy Fund I, LLC $ 250,554,961 $ 55,532,093 Altus Midstream Co-A 27,055,000 Apollo Credit Opportunities Fund III, LP 34,446,782 22,506,100 Apollo European Principal Finance Fund II 22,811,284 9,227,045 Apollo Financial Credit Investments Fund II 268,052,692 185,797,353 Apollo Financial Credit Investments Fund III 167,734,587 191,016,397 Apollo HK TMS Investments Holdings, LP 9,154,790 Apollo Offshore Credit Fund Ltd 283,451,384 Apollo Structured Credit Recovery Fund IV 134,631,035 97,681,754 Axton Holdings 643,862,276 Barings Asset-Based Income Fund, LP 119,531,782 176,984,278 Barings Global Real Asset Fund I 53,449,139 41,474,592 Blackstone Strategic Capital Holdings, LP 50,032,479 78,216,571 BroadRiver III, LP 9,231,557 190,586,537 BSCH Parallel (MLG) I, LP 100,047,077 38,874,114 Blue Peninsula Fund, LP 138,946,984 64,877,292 Carlyle Intl Energy Partners, LP 43,423,987 25,487,843 Carlyle Energy Mezzanine Opportunity Fund II 18,709,361 31,660,075 Centerbridge SCP III, LP 22,074,224 9,931,128 * Content Holdings, LLC 408,109,824 45,361,750 Elegantree Fund SPC 10,350,570 4,738,072 Energy Recapitalization and Restructuring Fund, LP 31,740,966 7,270,621 ERR Michigan Holdings, LP 4,946,227 2,269,933 * Fairfield Settlement Partners, LLC 51,800,468 81,078,084 FCO MA MI, LP 153,539,679 74,096,061 ** Flywheel Energy Co-Invest 28,000,000 7,000,000 Fortress MSR Opportunities Fund I A, LP 82,263,768 Fortress Transportation & Infrastructure 54,161,076 GSO Credit Alpha Fund, LP 56,796,543 37,910,064 Highbridge Principal Strategies - Specialty Loan Fund III 24,528,196 6,417,590 Hopen Life Sciences Fund II 4,553,020 1,090,000 HPS Red Cedar Fund 131,009,850 154,665,229 JP Morgan Global Maritime Investment Fund, LP 82,686,751 2,914,854 KANG Fund, LP 610,135 Kayne Anderson Energy Fund VII, LP 69,356,335 20,341,974 Kayne P.E. Income Fund 129,783,202 30,084,805 Kayne P.E. Income Fund II 30,750,000 119,250,000 Kayne Solutions Fund, LP 66,228,216 183,587,149 KKR EI&G Fund 55,891,148 4,162,083 KKR Lending Partners I, LP 18,112,698 11,930,723 KKR Lending Partners II, LP 45,462,147 11,737,239 Lakewater, LLC, Series 1 155,795,591 1,012,965 Lakewater, LLC, Series 2 352,606,502 11,041,654 7 Unfunded Net Market Value Commitment
Lakewater, LLC, Series 3 773,095,801 1,538,559 Lakewater, LLC, Series 4 31,610,594 2,196,174 Lakewater, LLC, Series 5 321,907,885 4,453,900 Marathon CLO Equity Fund, LP 12,927,284 12,045,000 Merit Energy Partners, LP 34,120,821 3,711,963 MidCap FinCo Holdings LTD 302,900,997 966,079 Napier Park Aircraft Leasing Vehicle I, LLC 37,360,060 16,594,142 Napier Park Aircraft Leasing Rollover Fund I, LLC 8,808,611 71,051,135 Nash Co-Investment 17,888,123 94,259 New Fortress Energy HLDGS 503,936,000 NGP Natural Resources XII 49,103,703 100,699,455 Orion Coinvest III, LP 8,591,680 2,236,552 Orion Mine Finance Fund 1A, LP 54,820,327 5,016,470 Orion Mine Finance Fund I, LP 102,468,837 7,376,051 Orion Mine Finance II, LP 69,665,860 39,612,107 Orion Mine Finance Co-Fund II, LP 15,506,455 34,927,191 Redding Ridge Holdings, LP 53,916,708 48,579,545 * Renaissance Venture Cap Fund II, LP 24,882,196 4,000,000 * Renaissance Venture Cap Fund III, LP 2,966,776 21,750,000 REOG Fund II Coinvest, LP 33,257,467 7,552,384 Ridgewood Energy Oil & Gas II 125,181,227 23,737,082 Ridgewood Energy Oil & Gas III 63,831,794 176,408,916 RPEP Energy Opp Inst Partner 19,501,564 24,100,819 SJC Direct Lending Fund I, LP 550,492 15,088,120 SJC Direct Lending Fund IA, LP 193,597 3,764,486 SJC Direct Lending Fund II, LP 43,038,774 38,261,315 SJC Direct Lending Fund III, LP 115,446,270 117,918,021 SJC Direct Lending Fund III Co-Invest G-III 20,000,000 * Social Network Holdings, LLC 110,029,928 19,540,969 Specialty Equity Strategy, LP 267,077 19,647,000 Sprott PRL (M), LP 5,892,678 19,057,857 Sprott PRL (M-Co-Invest) 7,971,194 17,137,500 Sprott Private Resource Lending Fund (US), LP 62,432,157 60,713,685 Terra Co-Investment, LLC 33,018,201 14,000,000 TICP CLO Partners II, LP 39,678,441 10,404,525 TSSP Adjacent Opp Partners, LP 124,373,636 189,430,788 ** TSSP Capital Solutions 48,507,052 250,095,649 TSSP Opportunities Partners IV, LP 100,000,000 Varo Coinvestment, LP 15,707,507 892,702 Vida Insurance Credit Opportunity Fund II, LP 89,221,118 10,116,433 Warwick Energy Partners III 54,588,554 7,454,932 Warwick (SMRS) Co-Invest, LP 31,255,040 2,732,720 Total Real Return and Opportunistic $ 7,916,706,776 $ 3,542,718,506 Short-Term Investments & Other 100,500,991 - Grand Total Total $ 8,017,207,767 $ 3,542,718,506
* Fund of Funds ** New Commitment
8 SMRS Real Return and Opportunistic 12/31/18
Investments By Strategy
Opportunistic Transportation Short-Term Equity 1.6% Investments & Metals & Mining 3.6% Other 4.2% 1.4%
Insurance Linked Securities 7.3%
Multi-Strategy Direct Lending 41.1% 8.7%
Opportunistic Credit 14.3%
Energy 17.8%
Investment Strategy Multi-Strategy $ 3,303,632,415 Energy 1,430,811,152 Opportunistic Credit 1,145,996,605 Direct Lending 701,243,021 Insurance Linked Securities 586,040,422 Metals & Mining 327,349,187 Opportunistic Equity 292,511,475 Transportation 128,855,422 Short-Term Investments & Other 100,768,068 Total Market Value $ 8,017,207,767
9 SMRS Real Return and Opportunistic 12/31/2018
$ Millions Invested Commitmentsaa
$8,017 $420 $101 $1,215
($238 ) $6,519
9/30/18 Capital Calls Cash Dist. Reported Value Short Term 12/31/18 Reported Value Received Change Investments Reported Value
$ Millions Outstanding Commitments
$335 $3,687 $736 $3,543
($1,215)
9/30/18 New Deals Capital Calls Recallable Returned 12/31/18 Outstanding Capital and Other Outstanding Commitments Commitments
10 SMRS Real Return and Opportunistic 12/31/18
Top Ten Advisors or Entities
($ in Millions)
Advisor or Entity Market Value
Barings Alternative Investments $ 2,452 Apollo Global Management 1,277 Domain Capital Advisors 820 Fortress Investment Group 740 Kayne Anderson Capital Partners 385 Orion Resource Partners 251 Ridgewood Energy 242 TPG Sixth Street Partners 213 Czech Asset Management 179 HPS Investment Partners 156
Total Market Value $ 6,715
11 State of Michigan Retirement System DOMESTIC EQUITY REVIEW State of Michigan Investment Board Meeting March 7, 2019
Jack A. Behar, CFA Senior Investment Manager Domestic Equity Division EXECUTIVE SUMMARY
Performance
MPSERS Plan (12/31/18) 1-Year 3-Years 5-Years 7-Years 10-Years Annualized Returns -3.8% 9.5% 8.3% 12.9% 13.3% S&P 1500 -5.0% 9.2% 8.3% 12.6% 13.2% Peer Median Return -5.9% 8.3% 7.6% 12.4% 13.0% Percentile Rank vs. Peers * 17 18 22 18 30 *State Street Universe greater than $1 billion
Total Domestic Equity outperformed its peer group and the S&P 1500 over all time periods, both gross and net of fees. Over the past year performance was 120 basis points (bps) in excess of the benchmark, with incurred tracking error of 1.8%.
SMRS pays roughly 8 bps per year in domestic equity fees versus its peer group at an estimated 20-25 bps (per the research of Aon/Hewitt in 2017), making net of fee peer group comparisons more favorable than what the table above indicates.
Combined internally managed active portfolios outperformed the S&P 1500 by 440 bps during the past year.
Performance driven by investments in Square, Validus Re (acquired by AIG), Twitter, Exelon, Annaly Capital Management and AGNC Investment Corp among others.
The SMRS Internal Large Cap Growth Fund returned 4.3% last year, ranking in the top decile of active growth managers on the year, and outpacing the S&P 500 by 930 bps.
Fisher Investments beat the S&P 1500 by 360 bps over the past year and ranks in the top 1% of its peer group since its inception in 2004.
LA Capital All-Cap Growth resumed its track record of outperformance, beating the S&P 500 by 550 bps over the past year and outpacing the S&P Growth Index over all time periods. This is particularly notable because such outperformance was achieved with a significantly lower risk profile than the underlying benchmark.
Ark Investments struggled in Q4 of 2018, but continues to outpace the S&P 1500 Growth benchmark by 1300 bps annualized since its inception date nearly three years ago.
Asset Class Goal
To provide the SMRS with long-term domestic equity market returns or better, by investing in a diversified and attractively valued portfolio of companies at an index fund-like cost.
1 Strategy Update
The Domestic Equity Portfolio remains overweight the financial sector and defensive stocks while remaining underweight the consumer discretionary, materials and energy sectors. The estimated portfolio beta is 1.1, so a significant market correction would present a modest headwind to performance.
o Total Domestic Equity’s portfolio would outperform the S&P 1500 by ~20% were it to appreciate to the market multiple of 15.3x from where it stands now at 12.7x, or if multiples between it and the benchmark were otherwise to converge.
o The potential for multiple convergence is driven by active exposures in Berkshire Hathaway, AGNC, Facebook, Gilead Sciences, Annaly Capital Management, and Ally Financial among others. All trade at forward PE ratios of 15x or less, with the exception of Facebook, which we believe to be undervalued despite its higher multiple.
o In the event that multiples do not converge, the division remains in a position to outperform based on its higher level of dividend yield, coupled with faster earnings per share growth than the S&P 1500.
o At the broader portfolio level, allocations to attractively valued financial and defensive stocks offset each other from an interest rate risk standpoint, paving the way for potential outperformance in most rate environments.
Market Environment and Outlook
At ~15.3x forward earnings, equity markets trade roughly in line with their historical average of 15.7x and 15% below their twenty-five-year historical average of 18x, albeit with higher levels of profitability, which may prove to be cyclical.
Factoring in the existing low level of interest rates, stocks are attractively priced for an environment where long-term bond yields are 4% or lower.
The market is currently paying out 2.2% of its earnings in dividends and reducing shares outstanding by 3.1% by way of share buybacks, for a 5.4% total shareholder yield.
It is also growing shareholders’ equity at a rate of 3.2% by reinvesting roughly 20% of its earnings back into its underlying businesses.
The market is thus poised to earn roughly 8.6% (shareholder yield of 5.4% + reinvestment rate of 3.2%) in an environment where stock multiples and returns on equity are stable.
This compares favorably to the 30-year U.S. Treasury at 3.0%, and unfavorably to the historical compound annual return for the S&P 500 from 1928 – 2017 of 9.5%.
2 SMRS Domestic Equity Strategies 12/31/18
Markets Amount Total % of Total
Internal Indexed ($ in Millions)
Indexed Portfolios $7,038
Total Indexed $7,038 44.9%
Internal Active
Active Portfolios $4,572
Total Internal Active $4,572 29.1%
External Active
Los Angeles Capital $1,081 Mellon Capital 670 Fisher Investments 607 Seizert Capital Partners 515 Clarkston Capital Partners 441 ARK Investments 383 Attucks Asset Management 133 Bivium Capital 128 Ancora 86 Munder Capital Management 20 Northpointe Capital 19
Total External Active $4,083 26.0%
Total Domestic Equity $15,693 100.0%
3 SMRS Domestic Equities Composite 12/31/18
Date: 12/31/18 9/30/18 6/30/18 3/31/18
Assets ($ in Millions): $15,693 $19,214 $17,831 $17,136 Number of Securities: 1,295 1,370 1,334 1,318 Active Share: 49% 44% 39% 37%
Description: The Domestic Equities Composite combines both the SMRS’ Actively Managed Composite and its index funds.
S&P 1500 Characteristics SMRS S&P 1500 Value Market Capitalization ($ in Billions) $196.2 $180.2 $140.5 P/E FY1 12.7x 15.3x 12.4x P/E upside to S&P 1500 20.6% 0.0 23.8% Price/Book 3.0x 2.8x 1.9x Return on Equity 22.8% 18.1% 15.7%
Risk Metrics Beta 1.10 1.00 0.88 Tracking Error 2.3% 0.0% 3.9%
Projected Returns Dividend Yield 3.2% 2.2% 2.8% Buyback Yield 3.3% 3.2% 3.7% Reinvestment Rate 4.0% 3.2% 3.0% Projected Investment Return 10.5% 8.6% 9.5%
TOP TEN EXPOSURES – Domestic Equities vs S&P 1500 12/31/18
Domestic Equity Portfolio S&P 1500
Portfolio FY1 Market FY1 Company Name Weight P/E Company Name Weight P/E SPDR S&P 500 ETF Trust 15.7% 15.5 Microsoft Corp. 3.4% 22.8 SPDR Port. LT Treasury ETF 7.1% 36.7 Apple, Inc. 3.1% 11.9 Berkshire Hathaway, Inc. B 3.8% 13.3 Amazon.com, Inc. 2.6% 75.1 Apple, Inc. 3.5% 11.9 Berkshire Hathaway, Inc. B 1.7% 13.3 Facebook, Inc. Class A 3.0% 18.3 Johnson & Johnson 1.5% 15.7 AGNC Investment Corp. 2.7% 7.3 Facebook, Inc. Class A 1.4% 18.3 Microsoft Corp. 2.1% 22.8 JPMorgan Chase & Co. 1.4% 10.5 Gilead Sciences, Inc. 1.8% 9.0 Alphabet, Inc., Class C 1.4% 25.2 Annaly Capital Mgmt., Inc. 1.7% 8.3 Alphabet, Inc., Class A 1.4% 25.4 Amazon.com, Inc. 1.7% 75.1 Exxon Mobil Corp. 1.3% 14.9 TOTAL 43.1% 15.2 TOTAL 19.2% 17.9
4 SMRS Domestic Equity By Sector 12/31/18
RE Materials Util. 2.6% 2.1% 2.6% Energy 3.3% Consumer Staples Financials 5.2% 25.8%
Consumer Discretionary 8.0%
Industrials 8.2%
Information Technology Communication 18.8% Services 9.8% Health Care 13.6%
Market Value in Millions 12/31/18
Assets Percent Benchmark Difference Financials $4,043 25.8% 13.7% 12.1% Information Technology 2,954 18.8% 19.6% -0.8% Health Care 2,130 13.6% 15.1% -1.5% Communication Services 1,535 9.8% 9.4% 0.4% Industrials 1,282 8.2% 9.9% -1.7% Consumer Discretionary 1,259 8.0% 10.2% -2.2% Consumer Staples 820 5.2% 7.0% -1.8% Energy 518 3.3% 5.1% -1.8% Utilities 411 2.6% 3.5% -0.9% Real Estate 405 2.6% 3.5% -0.9% Materials 336 2.1% 3.0% -0.9% Total $15,693 100.0% 100.0%
Benchmark: S&P 1500
5 SMRS Actively Managed Composite 12/31/18
Date: 12/31/18 9/30/18 6/30/18 3/31/18
Assets ($ in Millions): $8,655 $10,696 $9,879 $9,431 Number of Securities: 1,021 1,073 1,053 1,106 Active Share: 85% 77% 68% 65%
Description: The Actively Managed Composite is designed to add consistent alpha by investing in managers with value-added, but diverse strategies. While the expectation is that most will outperform over time, the composite is designed such that they do so during differing parts of the business cycle.
S&P 1500 Characteristics SMRS S&P 1500 Value Market Capitalization ($ in Billions) $164.0 $180.2 $140.5 P/E FY1 11.1x 15.3x 12.4x P/E upside to S&P 1500 37.7% 0.0 23.8% Price/Book 2.9x 2.8x 1.9x Return on Equity 26.1% 18.1% 15.7%
Risk Metrics Beta 1.18 1.00 0.88 Tracking Error 4.0% 0.0% 3.9%
Projected Returns Dividend Yield 4.1% 2.2% 2.8% Buyback Yield 3.4% 3.2% 3.7% Reinvestment Rate 4.3% 3.2% 3.0% Projected Investment Return 11.8% 8.6% 9.5%
TOP TEN EXPOSURES – Actively Managed Equities vs S&P 1500 12/31/18
Actively Managed Equity Portfolio S&P 1500
Portfolio FY1 Market FY1 Company Name Weight P/E Company Name Weight P/E SPDR S&P 500 ETF Trust 23.8% 15.5 Microsoft Corp. 3.4% 22.8 SPDR Port. LT Treasury ETF 12.9% 36.7 Apple, Inc. 3.1% 11.9 Berkshire Hathaway, Inc. B 6.0% 13.3 Amazon.com, Inc. 2.6% 75.1 AGNC Investment Corp. 4.9% 7.3 Berkshire Hathaway, Inc. B 1.7% 13.3 Facebook, Inc. Class A 4.4% 18.3 Johnson & Johnson 1.5% 15.7 Apple, Inc. 3.9% 11.9 Facebook, Inc. Class A 1.4% 18.3 Annaly Capital Mgmt., Inc. 3.1% 8.3 JPMorgan Chase & Co. 1.4% 10.5 Gilead Sciences, Inc. 3.0% 9.0 Alphabet, Inc., Class C 1.4% 25.2 Ally Financial, Inc. 2.2% 7.0 Alphabet, Inc., Class A 1.4% 25.4 Wells Fargo & Co. 2.0% 10.7 Exxon Mobil Corp. 1.3% 14.9 TOTAL 66.2% 13.8 TOTAL 19.2% 17.9
6 SMRS Active Equity By Sector 12/31/18
Energy RE Materials Utilities 1.9% 1.9% 1.3% 1.9% Consumer Staples 3.9% Consumer Discretionary Financials 6.3% 34.7% Industrials 7.4%
Communication Services 10.0%
Health Care 12.5% Information Technology 18.2%
Market Value in Millions 12/31/18
Assets Percent Benchmark Difference Financials $3,004 34.7% 13.7% 21.0% Information Technology 1,577 18.2% 19.6% -1.4% Health Care 1,085 12.5% 15.1% -2.6% Communication Services 865 10.0% 9.4% 0.6% Industrials 636 7.4% 9.9% -2.5% Consumer Discretionary 541 6.3% 10.2% -3.9% Consumer Staples 341 3.9% 7.0% -3.1% Utilities 168 1.9% 3.5% -1.6% Energy 168 1.9% 5.1% -3.2% Real Estate 161 1.9% 3.5% -1.6% Materials 109 1.3% 3.0% -1.7% Total $8,655 100.0% 100.0%
Benchmark: S&P 1500
7 Manager Performance - Net of Fees 12/31/18
Inception Fund Name Market Value 1-Year 3-Years 5-Years 7-Years Inception Date
SMRS S&P 500 Index $6,440,444,086 -4.3% 9.4% 8.6% 12.9% -- N/A S&P 500 -4.4% 9.3% 8.5% 12.7% -- Style & Risk Adjusted Benchmark -4.4% 9.2% 8.5% 12.7% -- Lipper Large-Cap Core -5.4% 8.1% 7.1% 11.5% -- Excess Return 0.1% 0.2% 0.1% 0.2% -- Alpha 0.0% 0.2% 0.2% 0.3% -- Pct. Rank vs. Lipper Large-Cap Core 33 21 13 12 --
SMRS Large-Cap Core 2,114,150,415 1.4% 10.7% 8.7% 13.8% 7.5% 8/31/07 S&P 500 -4.4% 9.3% 8.5% 12.7% 7.1% Style & Risk Adjusted Benchmark -0.5% 11.1% 8.4% 12.9% 7.5% Lipper Large-Cap Core -5.4% 8.1% 7.1% 11.5% 6.4% Excess Return 5.7% 1.4% 0.2% 1.1% 0.4% Alpha 1.8% -0.4% 0.3% 0.8% 0.0% Pct Rank vs Lipper Large-Cap Core 2 813 6 12
SMRS All-Cap Garp 1,447,372,850 -7.5% 6.9% 7.1% 12.6% 11.5% 4/30/11 S&P 1500 Super Composite -5.0% 9.2% 8.2% 12.6% 10.7% Style & Risk Adjusted Benchmark -4.7% 9.5% 8.5% 12.9% 10.8% Lipper Multi-Cap Core -7.9% 6.8% 5.6% 10.6% 8.5% Excess Return -2.6% -2.3% -1.2% 0.0% 0.8% Alpha -2.9% -2.7% -1.4% -0.3% 0.7% Pct. Rank vs. Lipper Multi-Cap Core 54 60 27 10 1
Mellon US Equity Enhanced 669,922,312 -8.2% ------13.5% 3/1/17 S&P 500 -4.4% ------5.3% Style & Risk Adjusted Benchmark -2.0% ------12.9% Lipper Large-Cap Core -5.4% ------4.5% Excess Return -3.8% ------8.2% Alpha -6.2% ------0.6% Pct. Rank vs. Lipper Large-Cap Core 87 ------1
LA Capital Deep Value 646,602,510 -10.8% 6.0% -- -- 3.7% 4/1/15 S&P 1500 Value -9.3% 7.3% -- -- 4.9% Style & Risk Adjusted Benchmark -9.4% 7.4% -- -- 5.0% Lipper Multi-Cap Value -11.4% 5.6% -- -- 2.9% Excess Return -1.6% -1.3% -- -- -1.2% Alpha -1.4% -1.4% -- -- -1.3% Pct. Rank vs. Lipper Multi-Cap Value 49 43 -- -- 34
Fisher All-Cap 606,768,840 -1.4% 11.1% 10.2% 13.1% 10.2% 10/31/04 S&P 1500 -5.0% 9.2% 8.2% 12.6% 8.2% Style & Risk Adjusted Benchmark 0.1% 9.9% 9.1% 13.8% 9.9% Lipper Multi-Cap Core -7.9% 6.8% 5.6% 10.6% 7.0% Excess Return 3.5% 1.9% 2.0% 0.5% 2.0% Alpha -1.5% 1.2% 1.1% -0.7% 0.4% Pct. Rank vs. Lipper Multi-Cap Core 5 1 1 5 1
SMRS Mid-Cap Index 597,932,465 -10.7% 8.4% 6.7% 12.0% -- N/A S&P 400 -11.1% 7.7% 6.0% 11.2% -- Style & Risk Adjusted Benchmark -11.1% 7.6% 6.0% 11.2% -- Lipper Mid-Cap Core -11.0% 5.9% 4.2% 9.7% -- Excess Return 0.4% 0.7% 0.6% 0.7% -- Alpha 0.4% 0.7% 0.7% 0.8% -- Pct. Rank vs. Lipper Mid-Cap Core 40 19 12 4 --
8 Inception Fund Name Market Value 1-Year 3-Years 5-Years 7-Years Inception Date
SMRS Large-Cap Growth 585,318,853 4.3% 9.0% 9.9% 14.2% 9.1% 5/31/05 S&P 500 Growth 0.0% 10.9% 10.6% 14.1% 9.3% Style & Risk Adjusted Benchmark -1.1% 11.8% 11.1% 15.0% 9.5% Lipper Large-Cap Growth -0.8% 9.7% 9.2% 13.5% 8.9% Excess Return 4.3% -1.9% -0.7% 0.2% -0.2% Alpha 5.4% -2.8% -1.3% -0.8% -0.3% Pct Rank vs Lipper Large-Cap Growth 7 69 35 27 36
Seizert Capital Partners 515,154,883 -7.2% 8.4% 5.5% 11.8% 12.1% 11/30/09 S&P 1500 Value -9.3% 7.3% 6.0% 11.1% 11.0% Style & Risk Adjusted Benchmark -4.1% 9.3% 6.1% 11.6% 11.2% Lipper Multi-Cap Value -11.4% 5.6% 4.2% 9.6% 9.5% Excess Return 2.1% 1.1% -0.5% 0.7% 1.1% Alpha -3.0% -0.9% -0.6% 0.2% 0.9% Pct. Rank vs. Lipper Multi-Cap Value 11 5 24 4 3
LA Capital All-Cap Growth 434,631,192 0.5% 10.8% 10.6% 14.9% 11.2% 5/31/05 S&P 1500 Growth -0.8% 10.6% 10.2% 13.9% 9.3% Style & Risk Adjusted Benchmark -0.5% 9.3% 8.8% 12.6% 8.8% Lipper Multi-Cap Growth -2.9% 8.4% 7.2% 12.2% 8.6% Excess Return 1.4% 0.1% 0.5% 1.1% 1.8% Alpha 1.1% 1.5% 1.8% 2.3% 2.4% Pct. Rank vs. Lipper Multi-Cap Growth 17 18 11 12 5
Large-Cap Consistent Growth 416,259,539 0.7% 9.5% -- -- 8.7% 3/1/15 S&P 500 -4.4% 9.3% -- -- 6.8% Style & Risk Adjusted Benchmark 0.2% 9.7% -- -- 7.8% Lipper Large-Cap Core -5.4% 8.1% -- -- 5.6% Excess Return 5.1% 0.2% -- -- 1.9% Alpha 0.6% -0.2% -- -- 0.9% Pct. Rank vs. Lipper Large-Cap Core 2 20 -- -- 4
Ark Investments 383,043,849 -3.9% ------26.9% 3/1/16 S&P 1500 Growth -0.8% ------13.6% Style & Risk Adjusted Benchmark -2.6% ------22.3% Lipper Multi-Cap Growth -2.9% ------12.4% Excess Return -3.1% ------13.2% Alpha -1.4% ------4.5% Pct. Rank vs. Lipper Multi-Cap Growth 53 ------1
Clarkston Capital Large-Cap 246,423,781 -7.7% 6.3% -- -- 5.8% 4/1/15 S&P 500 Value -9.0% 7.2% -- -- 5.0% Style & Risk Adjusted Benchmark -7.2% 5.7% -- -- 4.0% Lipper Large-Cap Value -8.0% 7.2% -- -- 4.8% Excess Return 1.3% -0.9% -- -- 0.8% Alpha -0.5% 0.6% -- -- 1.9% Pct. Rank vs. Lipper Large-Cap Value 36 69 -- -- 24
Clarkston Capital Small/Mid-Cap 194,154,506 -6.8% 7.3% 8.8% -- 8.8% 1/1/14 S&P 400 -10.3% 8.2% 6.1% -- 6.1% Style & Risk Adjusted Benchmark -2.7% 5.7% 4.6% -- 4.6% Lipper Mid-Cap Core -11.0% 5.9% 4.2% -- 4.2% Excess Return 3.5% -0.9% 2.7% -- 2.7% Alpha -4.0% 1.5% 4.2% -- 4.2% Pct. Rank vs. Lipper Mid-Cap Core 13 35 1 -- 1
Bivium Capital Partners 127,827,347 -12.2% 5.7% 4.3% 9.6% 4.9% 11/30/07 S&P 1500 Value -9.3% 7.3% 6.0% 11.1% 4.8% Style & Risk Adjusted Benchmark -9.9% 7.8% 6.3% 11.5% 7.0% Lipper Multi-Cap Value -11.4% 5.6% 4.2% 9.6% 4.2% Excess Return -2.9% -1.6% -1.6% -1.5% 0.1% Alpha -2.3% -2.1% -2.0% -2.0% -2.0% Pct. Rank vs. Lipper Multi-Cap Value 58 52 53 61 26
9 Inception Fund Name Market Value 1-Year 3-Years 5-Years 7-Years Inception Date
Attucks Asset Management 132,454,422 -7.3% 6.5% 5.1% 10.1% 5.5% 11/30/07 S&P 1500 -5.0% 9.2% 8.2% 12.6% 6.8% Style & Risk Adjusted Benchmark -4.3% 9.0% 8.2% 12.8% 6.8% Lipper Multi-Cap Core -7.9% 6.8% 5.6% 10.6% 5.2% Excess Return -2.4% -2.7% -3.2% -2.5% -1.2% Alpha -3.0% -2.5% -3.1% -2.7% -1.2% Pct. Rank vs. Lipper Multi-Cap Core 51 63 67 68 50
Ancora 86,411,512 -12.4% ------7.4% 10/1/17 S&P 1000 -10.3% ------4.3% Style & Risk Adjusted Benchmark -8.4% ------3.3% Lipper Mid-Cap Core -11.0% ------5.0% Excess Return -2.1% ------3.2% Alpha -4.0% ------4.2% Pct. Rank vs. Lipper Mid-Cap Core 69 ------77
Munder Concentrated SMID Cap 20,082,572 -17.6% 0.6% 1.2% 7.5% 11.6% 4/30/09 S&P 1000 -10.3% 8.2% 6.1% 11.5% 15.4% Style & Risk Adjusted Benchmark -11.8% 8.9% 6.6% 12.1% 14.5% Lipper Mid-Cap Core -11.0% 5.9% 4.2% 9.7% 13.3% Excess Return -7.3% -7.6% -4.9% -4.1% -3.8% Alpha -5.8% -8.3% -5.4% -4.7% -2.8% Pct. Rank vs. Lipper Mid-Cap Core 93 94 92 90 83
NorthPointe All-Cap Core 19,258,989 -9.7% 4.8% 3.1% 9.8% 6.3% 10/31/04 S&P 1500 Value -9.3% 7.3% 6.0% 11.1% 7.1% Style & Risk Adjusted Benchmark -7.6% 6.8% 5.4% 11.1% 9.1% Lipper Multi-Cap Value -11.4% 5.6% 4.2% 9.6% 6.1% Excess Return -0.4% -2.5% -2.8% -1.3% -0.8% Alpha -2.1% -2.0% -2.2% -1.3% -2.8% Pct. Rank vs. Lipper Multi-Cap Value 38 74 75 55 41
10 State of Michigan Retirement System PRIVATE EQUITY REVIEW State of Michigan Investment Board Meeting March 7, 2019
Peter A. Woodford Senior Investment Manager Private Equity Division EXECUTIVE SUMMARY
Performance
MPSERS Plan (12/31/18) 1-Year 3-Years 5-Years 7-Years 10-Years Annualized Returns 18.2% 14.8% 14.6% 14.9% 13.5% PE Benchmark Returns 21.4% 20.7% 17.2% 20.1% 19.1% Peer Median Returns 7.7% 9.5% 9.3% 10.3% 8.9% Percentile Rank vs. Peers* 7 11 14 10 7 *State Street Universe greater than $1 billion
Private Equity returns have been strong relative to peer median returns, ranking in the top 7% of peers over the past ten years. Outperformance to peers is attributable to fund selectivity and strategy. Given the nearly 10-year expansion and corresponding runup in U.S equities, it is not surprising that the Private Equity Division returns have lagged the benchmark somewhat. General Partners are slow to increase portfolio company valuations and even then, do so conservatively.
For the twelve months ending December 31, 2018, the Private Equity Division made contributions of approximately $103 million, net of distributions. Although the pace of distributions continues to slow, distribution activity should remain healthy for as long as the economic expansion continues. General Partners are incentivized to exit investments at current valuations.
Commitments closed during the quarter include: o $150 million to TSG 8, L.P., a branded consumer products buyout fund.
o $150 million to Warburg Pincus Global Growth, L.P., a multi-strategy, global growth fund.
o $125 million to KKR European Fund V (USD) SCSp, a Western Europe focused buyout fund.
o $100 million to Greenspring Master G, L.P., a venture focused separately managed account.
o $100 million to Flagship Pioneering Special Opportunities Fund II, L.P., a life sciences focused VC fund.
o $75 million to FS Equity Partners VIII, L.P., a consumer and distribution focused middle-market buyout fund.
o $30 million to 5AM Opportunities I, L.P., a late-stage life sciences VC fund.
o $25 million to Greenspring Micro II, L.P., a micro-VC fund-of-funds.
o $20 million to 5AM Ventures VI, L.P., an early-stage life sciences VC fund.
Strategy Update
The strategy for the next twelve months will focus on new sponsors raising capital and existing sponsors raising successor funds. This may be a combination of buyout, venture capital, secondary, and growth equity funds seeking new commitments. The Private Equity Division continues to tilt slightly toward the middle and lower-middle market to diversify its exposure to large funds. Co-investments continue to play an important role in both averaging down costs and targeting specific investments with attractive risk/return characteristics.
1 SMRS Private Equity 12/31/18
Mezzanine Cash/ Funds Other Liquidation 1.9% 1.6% Portfolio 9.1%
Venture Capital Funds 12.0% Buyout Funds 45.1%
Special Situation Funds 14.8%
Fund of Funds 15.5%
Market Value in Millions
12/31/18 12/31/17 Buyout Funds $5,662 45.1% $4,872 45.8% Fund of Funds 1,939 15.5% 1,196 11.3% Special Situation Funds 1,850 14.8% 1,704 16.0% Venture Capital Funds 1,511 12.0% 1,162 10.9% Liquidation Portfolio 1,136 9.1% 1,249 11.7% Mezzanine Funds 238 1.9% 197 1.9% Cash/Other 204 1.6% 249 2.4% Total $12,540 100.0% $10,629 100.0%
2 SMRS Private Equity 12/31/18
($ in Millions) $834 $12,540 $11,971 $455
($18) ($220) ($482)
9/30/18 Capital Cash Stock Reported Cash 12/31/18 Reported Calls Dist. Dist. Value Balance Reported Value Received Received Change Change Value
($ in Millions) $7,327 $775 $7,320 $17 $40
($5) ($834)
9/30/18 New Capital FX Recallable Other 12/31/18 Outstanding Deals Calls Change Returned Outstanding Commitments Capital Commitments
3 SMRS Private Equity 12/31/18
Investments by Industry
Telecommunication Real Estate Services 1.2% Materials 3.1% 3.5% Utilities Consumer 1.0% Staples 3.8%
Financials Information 5.6% Technology 22.5%
Energy 6.3%
Health Industrials Care 11.4% 16.0%
Consumer Discretionary Other 11.8% 13.8%
These numbers are based on the most recent available General Partner Data; primarily 9/30/18 and are subject to change.
4 SMRS Private Equity 12/31/18
Investments by Region
Western Europe Asia/Africa 10.7% 7.3% Eastern Canada Europe 1.8% 0.4%
United Kingdom 5.0%
U.S.
5 Northwest 13.0% U.S. Mid- U.S. New Atlantic England 3.8% 21.8%
U.S. North Central 10.3%
U.S. U.S. Southeast Southwest Latin 7.9% 17.0% America 0.4% U.S. Offshore 0.3% Represents Companies with 0.3% Untrackable Regions, i.e.; Fund of Funds
Geographic Report: North America 76%, Europe 16%, Asia 7%, Other 1% SMRS Private Equity 12/31/18
Portfolio by Vintage Year
($ in Millions)
Reported Outstanding Total Asset Vintage Value Commitment Exposure 1986-98 $ 2 $ 2 $ 4 1999 6 5 11 2000 47 23 70 2001 117 60 177 2002 6 4 10 2003 6 13 19 2004 93 35 128 2005 220 24 244 2006* 582 171 753 2007 513 131 644 2008 661 100 761 2009 44 1 45 2010 256 4 260 2011 697 107 804 2012 1,376 117 1,493 2013 408 120 528 2014 1,446 349 1,795 2015 4,074 1,247 5,321 2016 1,222 1,067 2,289 2017 339 1,321 1,660 2018 222 2,419 2,641 Income Accruals 1 0 1 Cash 194 0 194 Act. Small Cap - Stock Dist 8 0 8 Total $ 12,540 $ 7,320 $ 19,860
*Liquidation portfolio is 2006 vintage
FX Exposure
($ in Millions)
Reported Outstanding Total Total Value Commitment Exposure (USD) Euro ($1.14/ €) € 396 € 352 € 748 $855
6 SMRS Private Equity 12/31/18
Top 10 Sponsors
($ in Millions) Reported Outstanding Asset Type Value Commitment Total HarbourVest Partners $ 2,626 $ 614 $ 3,240 KKR 555 401 956 Warburg Pincus Capital 621 303 924 Blackstone Capital Partners 538 329 867 The Carlyle Group 366 493 859 Grosvenor Capital Management 595 121 716 Advent International 464 114 578 Leonard Green & Partners 424 149 573 TPG 257 220 477 The Riverside Company 223 238 461 Top 10 Total Value $ 6,669 $ 2,982 $ 9,651
Cash Weighted Rates of Return*
(Net IRR) Current Qtr. 1-Year 3-Year 5-Year 10-Year Buyout -0.2% 13.8% 16.0% 14.2% 17.0% Fund of Funds 2.0% 19.5% 16.4% 13.7% 11.1% Mezzanine 0.4% 10.8% 11.1% 7.6% 11.9% Special Situations -0.1% 9.1% 11.2% 9.3% 13.3% Venture Capital 0.2% 24.0% 14.6% 16.4% 20.7%
*These numbers are based on most recent available General Partner reported data; primarily 9/30/18 and are subject to change.
7 SMRS Private Equity 12/31/18 Net Market Values by Ownership Entity
Adjusted Unfunded Reported Value Commitment
** 5AM Opportunities I, L.P. $ 2,175,000 $ 27,825,000 ** 5AM Ventures VI, L.P. 200,000 19,800,000 Accel Europe I, L.P. 3,230,543 1 Accel Europe II 16,023,485 3,300,000 Accel Growth Fund II, L.P. 18,298,227 240,000 Accel Growth Fund III, L.P. 16,476,498 1,120,000 Accel Growth Fund IV L.P. 17,924,420 3,740,000 Accel IX, L.P. 5,066,074 3,000,000 Accel Leaders Fund L.P. 6,126,498 330,000 Accel London V L.P. 8,639,969 4,320,000 Accel VI-S 2,232,087 652,611 Accel VI, L.P. 1,004,899 - Accel VIII, L.P. 290,145 4,782,499 Accel X, L.P. 17,775,124 - Accel XI, L.P. 8,208,482 1,680,000 Accel XII, L.P. 6,129,563 1,190,000 Accel XIII, L.P. 5,188,032 4,800,000 Advent Global Private Equity V 7,551,796 8,700,000 Advent International GPE VI-A LP 50,888,223 - Advent International GPE VII-B, L.P. 217,355,650 12,000,000 Advent International GPE VIII-B, L.P. 169,388,119 78,975,000 Advent Latin American Private Equity Fund VI, L.P. 18,869,423 14,140,000 Affinity Asia Pacific Fund III, L.P. 42,134,680 10,687,479 Affinity Asia Pacific Fund IV, L.P. 112,039,187 19,149,634 Affinity Asia Pacific Fund V L.P. 10,008,170 164,991,830 Apax Digital, L.P. 4,777,620 45,108,993 Apax Europe Fund VI 19,319,637 2,417,531 Apax Europe VII, L.P. 27,717,495 1,702,585 Apax IX, L.P. 79,559,519 85,005,421 Apax US VII 10,812,628 417,509 Apax VIII - B, L.P. 99,008,004 7,322,257 Apollo Investment Fund IX, L.P. - 100,000,000 Apollo Investment Fund VIII L.P. 92,627,734 18,356,765 Arboretum Ventures II 2,168,444 - Arboretum Ventures III, L.P. 15,512,680 - Arboretum Ventures IV, L.P. 20,794,312 14,040,000 Ares Corporate Opportunities Fund II 7,210,466 11,423,773 Ares Corporate Opportunities Fund III, LP 76,782,705 8,551,001
8 Adjusted Unfunded Reported Value Commitment
Ares Corporate Opportunities Fund IV, L.P. 93,985,523 18,229,028 ASF VIII B 15,000 149,985,000 AXA ASF Miller Co-Investment 480,418 6,656,684 Axiom Asia Co-Investment Fund I, L.P. 3,727,576 46,248,591 Axiom Asia IV, L.P. 33,964,382 19,447,811 Axiom Asia Private Capital Fund III, L.P. 47,325,270 6,649,264 Axiom Asia V, L.P. 1,423,532 48,500,000 BC European Capital IX 74,781,732 1,925,447 BC European Capital VII, L.P. 558,669 - BC European Capital VIII, L.P. 24,595,003 8,912,507 Berkshire Fund IX Coinvestment Fund, L.P. 6,838,046 42,932,166 Berkshire Fund IX, L.P. 68,859,965 99,994,192 Berkshire Fund VI, L.P. 36,911,573 7,600,677 Berkshire Fund VII, L.P. 30,961,009 2,449,845 Berkshire Fund VIII, L.P. 70,470,178 9,463,285 Blackstone Capital Partners IV 17,599,511 4,729,676 Blackstone Capital Partners V 23,937,353 13,069,148 Blackstone Capital Partners V-S 1,646,467 712,476 Blackstone Capital Partners VI, LP 290,278,001 43,877,598 Blackstone Capital Partners VII, L.P. 137,271,668 158,963,185 Bridgepoint Europe IV 34,348,544 6,103,612 Carlyle Europe Partners II 894,509 4,227,306 Carlyle Europe Partners III 13,412,700 6,078,167 Carlyle Europe Partners IV, L.P. 120,698,931 13,106,304 Carlyle Europe Partners V, S.C.SP. - 142,893,747 Carlyle Partners IV, L.P. 5,639,952 16,009,296 Carlyle Partners V L.P. 53,774,966 54,261,025 Carlyle Partners VI, L.P. 163,469,662 14,218,009 Carlyle Partners VII, L.P. 8,066,219 241,933,781 Centerbridge Capital Partners III, LP 39,410,896 46,875,089 Cerberus SMRS Partners, L.P. 50,800,547 23,304,657 Charlesbank Equity Fund IX, L.P. 14,607,854 85,515,021 Charlesbank Fund IX Overage Allocation Program 14,438,323 35,696,334 CM Liquidity Fund, L.P. - 25,000,000 Coller International Partners V, L.P. 21,207,615 43,600,000 Coller International Partners VI, L.P. 34,699,293 29,723,267 Coller International Partners VII, L.P. 104,182,644 63,040,960 Crescent Mezzanine Partners VI, L.P. 31,623,003 8,496,178 Crescent Mezzanine Partners VII 18,448,246 132,247,053 CVC Capital Partners VII, L.P. 27,097,662 144,374,834 DLJ Investment Partners III - 764,960 Dover Street IX, L.P. 55,889,254 47,000,000 EnCap Energy Capital Fund X, L.P. 34,797,417 11,099,951 Entertainment IP Fund, L.P. 16,149,474 33,767,382 FIMI Opportunity 6, L.P. 16,297,637 34,681,820 FirstMark Capital I, L.P. 79,390,642 196,596
9 Adjusted Unfunded Reported Value Commitment
FirstMark Capital IV, L.P. 11,205,791 24,150,000 FirstMark Capital OF I, L.P. 26,417,035 - FirstMark Capital OF II, L.P. 17,389,766 17,500,000 FirstMark Capital P2, L.P. 168,082,451 - ** Flagship Pioneering Special Opportunities Fund II, L.P. - 100,000,000 Flagship Pioneering VI 20,009,033 56,250,000 Flagship Ventures Fund 2004 8,738,655 - Flagship Ventures Fund 2007, L.P. 16,475,524 - Flagship Ventures Fund IV, L.P. 146,703,193 - Flagship Ventures Fund V 78,656,222 1,925,000 Flagship Ventures Opportunities Fund I, L.P. 35,561,524 23,250,000 Fox Paine Capital Fund II, LP 29,904,001 15,382,699 FS Equity Partners VII, L.P. 92,400,054 22,793,183 ** FS Equity Partners VIII, L.P. - 75,000,000 G-IV Acquisition Holdings, LLC 13,521,776 - GCM Grosvenor Fund Investment Program I, L.P. 9,699,624 1,330,800 GCM Grosvenor Fund Investment Program II, L.P. 40,298,267 13,896,317 GCM Grosvenor Fund Investment Program III - 2004 46,157,767 4,536,596 GCM Grosvenor Fund Investment Program III - 2006 51,027,846 7,021,779 GCM Grosvenor Fund Investment Program V, L.P. 58,988,375 10,248,911 GCM Grosvenor Fund Investment Program VI, L.P. 24,271,490 8,093,934 GCM Grosvenor Fund Investment Program VIII, L.P. 71,903,730 27,812,528 GCM Grosvenor SeasPriFIP LP (PIS06-10) 59,415,887 16,989,604 GCM Grosvenor SeasPriFIP LP (PIS14) 197,352,451 17,238,325 GCM Grosvenor SeasPriFIP LP (Seed) 36,139,814 13,769,012 Genstar Capital Partners VIII, L.P. 32,764,283 23,431,443 Genstar VIII Opportunities Fund I, L.P. 47,396,093 7,055,029 Green Equity Investors IV 4,554,598 1,136,036 Green Equity Investors V 196,143,730 25,966,435 Green Equity Investors VI, L.P. 130,710,292 13,451,824 Green Equity Investors VII, L.P. 91,935,935 108,856,779 ** Greenspring Master G, L.P. - 100,000,000 ** Greenspring Micro II, L.P. 2,783,737 22,216,263 GSO Capital Opportunities Fund II, L.P. 15,530,781 11,316,595 GSO Capital Opportunities Fund III, L.P. 39,394,382 59,131,802 GSO COF III Co-Investment Fund, L.P. 12,816,567 36,775,532 HarbourVest Dover Street VIII, L.P. 28,333,774 6,750,000 HarbourVest Int'l III Partnership 165,353 1,200,000 Harbourvest Partners Co-Investment Fund IV L.P 83,187,591 25,893,830 HarbourVest Partners Mezzanine Income Fund 66,763,587 39,810,000 HarbourVest V Partnership 167,309 300,000 HarbourVest VI - Direct Fund LP 2,916,478 750,000 HarbourVest VI Partnership 1,071,677 2,000,000 Harvest Partners VII, L.P. 43,358,335 34,449,033 HPS Mezzanine Partners III, L.P. 37,019,752 14,365,364 Insight Venture Partners Growth-Buyout Coinvestment Fund 77,951,487 9,343,979
10 Adjusted Unfunded Reported Value Commitment
Insight Venture Partners IX, L.P. 151,648,457 5,053,257 Insight Venture Partners X, L.P. 41,722,447 59,000,000 Kelso Investment Associates IX, L.P. 101,997,567 24,376,732 Kelso Investment Associates VII 2,140,842 4,970,176 Kelso Investment Associates VIII 64,837,872 22,099,885 Kelso Investment Associates X, L.P. 523,134 99,476,866 Khosla Ventures III, L.P. 41,260,949 750,000 Khosla Ventures IV, L.P. 87,604,776 950,000 Khosla Ventures Seed D, L.P. 1,358,797 8,600,000 Khosla Ventures V, L.P. 51,668,137 6,600,000 Khosla Ventures VI, L.P. 16,856,280 57,900,000 KKR 2006 Fund, L.P. 92,813,696 4,955,653 KKR Americas Fund XII, L.P. 71,160,872 131,262,441 KKR Asian 7,314,739 - KKR Asian Fund II, L.P. 52,610,320 5,184,705 KKR Asian Fund III 18,408,611 82,499,074 KKR China Growth Fund 28,628,632 3,383,656 KKR E2 Investors (Annex) Fund - - KKR European Fund II 1,541,285 - KKR European Fund III 27,249,468 6,272,565 KKR European Fund IV L.P. 115,686,386 31,367,379 ** KKR European Fund V (USD) SCSp - 125,000,000 KKR Millennium Fund 599,832 - KKR North America Fund XI, L.P. 138,510,971 11,420,076 Lead Edge Capital IV, L.P. 8,687,197 16,239,201 Lightspeed Venture Partners VI 583,192 - Lightspeed Venture Partners VII, L.P. 10,860,415 - Menlo Ventures IX, L.P. 1,456,181 - Menlo Ventures X, L.P. 21,058,096 - Menlo Ventures XI, L.P. 45,736,804 - Menlo Ventures XIV, L.P. 2,998,882 4,200,000 MeriTech Capital Partners II, L.P. 1,681,758 1,850,000 Meritech Capital Partners III, L.P. 1,546,655 - Meritech Capital Partners IV, L.P. 13,494,446 900,000 Meritech Capital Partners V, L.P. 21,425,430 1,450,000 Meritech Capital Partners VI, L.P. 9,233,018 30,437,500 Michigan Growth Capital Partners II, L.P. 196,058,985 11,200,371 Michigan Growth Capital Partners III, L.P. 25,495,468 87,233,254 Michigan Growth Capital Partners, LP 51,296,989 11,621,398 Midtown Fund III, L.P. - - Midtown II Liquidating Trust - - New Leaf Biopharma Opportunities II, L.P. 84,061,103 28,000,000 New Leaf Growth Fund I, L.P. 218,864,315 - New Leaf Ventures II, L.P. 17,475,312 - New Leaf Ventures III, L.P. 43,123,555 7,312,500 New Leaf Ventures IV, L.P. 8,944,674 40,812,500
11 Adjusted Unfunded Reported Value Commitment
Nordic Capital VI, L.P. 855,732 1 Nordic Capital VII 5,134,095 3,147,252 Nordic Capital VIII, L.P. (Alpha) 38,428,437 12,195,042 Oak Investment Partners X, L.P. 7,061,059 - Oak Investments Partners IX, L.P. 797,717 - Oaktree Opportunities Fund X, L.P. 31,400,440 5,100,000 Oaktree Opportunities Fund Xb, L.P. 8,683,924 61,250,000 OCM Opportunities Fund IX, L.P. 60,551,892 - OCM Opportunities Fund VII (B), L.P. 1,511,481 5,000,000 OCM Opportunities Fund VII, L.P. 2,446,868 - OCM Opportunities Fund VIII B, L.P. 21,301,682 - OCM Opportunities Fund VIII, L.P. 2,684,459 - OCM Principal Opportunities Fund IV 1,341,165 5,002,377 Ocqueoc Holdings, LLC 13,602,380 49,650,991 Parthenon Investors II 1,027,745 3,186,779 Parthenon Investors III 30,060,306 2,732,182 Parthenon Investors IV, L.P. 57,250,180 3,901,540 Peninsula Capital Fund IV 1,056,949 2,201,026 Peninsula Fund VI, L.P. 26,213,805 14,703,844 Permira Growth Opportunities I, L.P.1 - 50,000,000 PPC Fund II 20,517,088 54,786,949 Public Pension Capital, LLC 49,694,030 64,901,099 Rhone Partners V, L.P. 64,960,149 55,251,559 Riverside Capital Appreciation Fund VI, LP 62,941,073 11,792,789 Riverside Capital Appreciation Fund VII, L.P. - 100,000,000 Riverside Micro Cap Fund I, LP 17,923,710 5,782,975 Riverside Micro-Cap Fund II, L.P. 39,154,173 2,735,834 Riverside Micro-Cap Fund III, L.P. 57,786,956 7,261,513 Riverside Micro-Cap Fund IV 45,233,435 10,639,880 Riverside Micro-Cap Fund V, L.P. - 100,000,000 Science Ventures Fund II, L.P. 11,308,668 8,600,000 Shamrock Growth Capital Fund IV, L.P. 15,211,575 32,333,432 Silver Lake Partners II 486,982 3,531,586 Silver Lake Partners III 75,744,827 13,199,137 Silver Lake Partners IV, L.P. 65,837,922 5,175,296 Silver Lake Partners V, L.P. 15,265,007 51,459,240 SK Capital Partners V, L.P. 6,579,842 40,448,640 SM/TCP L.P. 38,248,041 1,615,217 SMRS - TOPE LLC 1,526,798,259 216,520,315 SMRS-CAPP LLC 17,161,137 83,300,000 SMRS-NCRP LLC 843,450,913 190,958,521 Sycamore Partners III, L.P. 10,266,597 87,547,283 TCW/Crescent Mezzanine Partners III Secondary 29,860 - TCW/Crescent Mezzanine Partners III, L.P. 154,406 29,733,856 TCW/Crescent Mezzanine Partners IV, L.P. 252,867 13,660,773 TCW/Crescent Mezzanine Partners IVB Secondary 223,555 -
12 Adjusted Unfunded Reported Value Commitment
TCW/Crescent Mezzanine Partners V, LLC 11,687,412 15,382,013 TCW/Crescent Mezzanine Partners VC Secondary 3,520,506 - The Huron Fund III, L.P. 8,117,157 4,207,756 The Huron Fund IV, L.P. 26,653,119 3,139,460 The Huron Fund V, L.P. 4,137,593 30,030,000 The Shansby Group 4 29,849 521,018 The Shansby Group 5 (TSG5) 1,666,812 4,261,291 Thoma Bravo Discover Fund II, L.P. 12,351,281 62,648,719 Thoma Bravo Fund XII, L.P. 145,714,718 17,184,726 Thoma Bravo Fund XIII, L.P. - 125,000,000 TI Platform BOV, L.P. 979,577 14,020,423 TI Platform Fund II, L.P. 1,070,262 13,929,738 TI Platform SMRS SMA, L.P. 8,333,314 51,666,686 TPG Healthcare Partners, L.P. - 25,000,000 TPG IV (Texas Pacific Group IV) 2,181,103 211,725 TPG Partners III, LP 767,444 2,087,002 TPG Partners VI, L.P. 93,869,447 10,258,102 TPG Partners VIII, L.P. - 125,000,000 TPG Partners, VII, L.P. 123,043,026 51,262,349 TPG V (Texas Pacific Group V) 37,528,681 5,841,509 Trilantic Capital Partners V (North America) Fund A, L.P. 33,874,842 5,981,109 Trilantic Capital Partners VI (North America) L.P. 14,690,301 59,387,727 TSG6, L.P. 103,233,697 28,250,905 TSG7 A L.P. 90,150,778 43,182,273 ** TSG8, L.P. - 150,000,000 Turnbridge Capital Partners I , LP 87,828,883 18,632,872 Veritas Capital Fund V, L.P. 122,617,248 1,708,273 Veritas Capital Fund VI, L.P. 54,741,090 42,901,584 Veritas V Co-Investors, L.P. 36,510,843 - Vista Equity Endeavor Fund I, L.P. 36,502,531 15,285,734 Vista Equity Partners Fund V, L.P. 55,453,372 15,224,819 Vista Equity Partners Fund VI, L.P. 67,875,731 7,652,071 Vista Equity Partners VII, L.P. - 75,000,000 Vista Foundation Fund III, L.P. 12,998,538 12,557,402 Warburg Pincus China, L.P. 37,055,961 14,377,500 Warburg Pincus Energy MCIP, L.P. - 10,396,887 Warburg Pincus Energy, L.P. 71,833,518 34,600,000 Warburg Pincus Equity Partners, L.P. 965,779 - Warburg Pincus Financial Sector, L.P. 8,632,194 35,460,000 ** Warburg Pincus Global Growth, L.P. - 150,000,000 Warburg Pincus International Partners 4,442,111 - Warburg Pincus Private Equity IX 13,081,929 - Warburg Pincus Private Equity VIII, L.P 6,851,701 - Warburg Pincus Private Equity X, L.P. 134,467,529 - Warburg Pincus Private Equity XI, L.P. 188,875,617 - Warburg Pincus Private Equity XII Secondary, L.P. 19,338,679 7,325,000
13 Adjusted Unfunded Reported Value Commitment
Warburg Pincus Private Equity XII, L.P. 135,569,871 51,275,000 WestAm COREplus Private Equity QP 368,709 2,086,719 Total Private Equity $ 12,336,259,107 $ 7,320,344,959
Cash 179,337,693 - Active Small Cap Cash 15,020,396 - Active Small Cap 7,996,784 - Income Accruals 1,176,841 - Grand Total $ 12,539,790,821 $ 7,320,344,959
Total Private Equity amounts do not include Cash and Active Small Cap ** New Commitments made during quarter reported
14 State of Michigan Retirement System INTERNATIONAL EQUITY REVIEW State of Michigan Investment Board Meeting March 7, 2019
Patrick M. Moraniec, CFA Senior Investment Manager International Equity Division EXECUTIVE SUMMARY
Performance
MPSERS Plan (12/31/18) 1-Year 3-Years 5-Years 7-Years 10-Years Annualized Returns -14.3% 4.7% 2.0% 6.1% 7.5% MSCI ACWI ex USA Returns -14.2% 4.5% 0.7% 5.0% 5.8% Peer Median Returns -14.2% 4.1% 1.3% 6.3% 7.6% Percentile Rank vs. Peers* 54 23 32 57 53 *Source: State Street Universe greater than $1 billion
The International Equity Division (IED) portfolio underperformed the benchmark by 0.1% over the last twelve months primarily due to the underperformance of emerging markets and the information technology sector. Outperformance in the internal stock plus strategy (190 bps) helped to mitigate the division’s underperformance.
Asset Class Goals
Construct a non-U.S. equity-focused portfolio to generate, on a consistent basis, ten-year returns that exceed the MSCI ACWI ex USA by 1.0%.
Perform in the top half of the public plan peer universe percentile rankings.
Advance people, processes, and systems to continuously improve investment decisions.
Strategy
The International Equity Division has three distinct portfolio strategies.
o Active investments, 36.5% of assets, to gain specific international stock market exposures.
o Stock plus investments, 34.9% of assets, to implement a portable alpha strategy onto high-level strategic tilts.
o Index investments, 28.6% of assets, to gain broad international stock market exposure with minimal tracking risk.
Current portfolio drivers of risk and return.
o Tracking error of the portfolio is approximately 0.7% which is below the division’s risk budget of 3.0%.
o Emerging markets, a large contributor to tracking error, is one-fifth of the total tracking error indicating the portfolio is not materially exposed to any one single risk.
o Future portfolio returns will be driven by the performance of the quality factor, value factor, momentum factor, and emerging markets overweight.
1 Quarterly changes to International Equity Division allocation.
o Rebalanced $1.2 billion of maturing equity swaps to MSCI factor indexes increasing the portfolio’s exposure to the quality, value and momentum factors. The combined allocation has an estimated information ratio of 0.6.
o Allocated $825.0 million to the BlackRock MSCI Systematic Return strategy. IED designed this multi-factor custom index strategy to improve the consistency of the division’s excess returns at low cost of 6 bps. Over long investment horizons IED estimates the strategy should produce excess returns of approximately 170 bps with an information ratio of around 1.0.
Market Environment and Outlook
Last calendar year represented the worst annual performance for international stock markets since the Great Financial Crisis of 2008. The MSCI ACWI ex USA index was down -14.2% in 2018 with events in China, Turkey, South Africa, United Kingdom and Italy weighing on markets.
Emerging markets were volatile in 2018. From the January 2018 high to October low the peak-to-trough drawdown was approximately 26.0%. Since October, emerging markets have outperformed the MSCI ACWI ex USA by 460 bps drawing almost even with broader international market for 2018. IED has been overweight emerging markets the past two years which has outperformed the MSCI ACWI ex USA by 540 bps through January of 2019.
In 2018, analysts continuously revised downward their forward-looking estimates for earnings-per-share. Over the next twelve months analysts expect earnings-per-share to grow approximately 10.0%. Expectations for growth have not been this low since 2015. Low expectations potentially represent a catalyst for positive international stock returns in 2019.
Lower analyst expectations were driven from below average realized growth. International stock markets’ top line continued to grow, albeit at a slower pace than the first half of the year. Sales grew 2.1% year-over-year through early February 2019 for the MSCI ACWI ex USA which is below the 5.4% twenty-year average.
Manufacturing PMIs serve as proxy for forward-looking economic activity. Country by country analysis of the top 80% of the index market capitalization weights shows most country manufacturing PMIs still contracting.
World trade volumes, another economic growth proxy, grew year-over-year at 2.8%. The rate of growth is below the twenty-year average of approximately 5.0%. On-going trade disputes between US, Europe and China may explain the subdued growth.
U.S. and China trade discussions, which are now over a year old, continue to evolve. The November G-20 meeting between President Trump and President Xi bought China four extra months of negotiating time. If a deal can’t be reached by March 2019 President Trump plans to move forward with increasing tariffs to 25% on the $200 billion of additional goods announced in 2018 plus potential tariffs on all remaining Chinese imports of approximately $267 billion.
2 Stock prices may reflect much of this slower economic reality. For example, the MSCI ACWI ex USA trailing twelve-month normalized price-to-earnings ratio is 16.8 well below the twenty-year average of 22.3 implying return upside should earnings growth pick-up.
International stock market breadth indicates a bottom developed in December 2018. Incrementally less negative economic indicators would further support a market bottom.
In 2018, the ECB discussed tightening monetary policy in 2019. More recently the ECB appears less certain this will be a 2019 event. The global slowdown in growth and the pause in U.S. Federal Reserve policy indicates central banks will remain accommodative through 2019.
Go-forward annualized returns for the MSCI ACWI ex USA index are estimated at 9.1%. This rate is based on the current price and actual fundamentals over multiple periods to remove fundamental variability, better estimating the earnings power of the index.
A ten-year blended international government yield of 1.6% implies an international equity risk premium of 7.5%. The premium expanded primarily due to a fall in global government interest rates over the last year. Lower government bond interest rates should support the recent softer global growth.
Conclusion
International stock market returns in 2018 were the worst since the Great Financial Crisis of 2008. Earnings-per-share however was flat leading to further contraction of an already attractive earnings multiple. The slowdown in growth from 2017 to 2018 resulted in downward revisions to analyst estimates, which are now the most pessimistic since 2015. With no multiple expansion the analysts are indicating 2019 international stock market returns of about 10%. IED believes continued accommodation from central banks will backstop any further slowdown in global economy. A potential resolution on trade could lead to a pick-up in economic activity and a rerating of international multiples which would be additive to the earnings growth projections for 2019.
3 SMRS International Equity Strategies 12/31/18
Markets Amount Total % of Total
Active ($ in Millions)
Los Angeles Capital Management $1,193 Wellington 887 BlackRock MSCI 826 Marathon-London 267 Effissimo Capital Management 222 SSGA 218 Lazard 218 Martin Currie 211
Total Active $4,043 36.5%
Stock Plus
Internal Stock Plus $2,311 PIMCO 1,557
Total Stock Plus $3,868 34.9%
Indexed SSGA $1,994 BlackRock 1,179
Total Indexed $3,173 28.6%
TOTAL $11,084 100.0%
4 SMRS International Equity Exposure By Category 12/31/18
Indexed Emerging Cash/Other Markets 0.5% 7.5% Active Emerging Markets 8.2% Active Developed Markets 27.8%
Stock Plus Emerging Markets 13.7%
Stock Plus Developed Markets Indexed Developed 21.2% Markets 21.1%
Market Value in Millions
12/31/18 12/31/17 Active Developed Markets $3,081 27.8% $4,067 31.3% Emerging Markets 906 8.2% 722 5.6% Cash/Other 56 0.5% 0 0.0% Total Active Equity $4,043 36.5% $4,789 36.9% Stock Plus Developed Markets $2,348 21.2% $3,938 30.3% Emerging Markets 1,520 13.7% 598 4.6% Total Stock Plus Equity $3,868 34.9% $4,536 34.9% Indexed Developed Markets $2,339 21.1% $2,475 19.0% Emerging Markets 834 7.5% 1,190 9.2% Total Indexed Equity $3,173 28.6% $3,665 28.2% Total International Equity $11,084 100.0% $12,990 100.0%
5 SMRS International Equities 12/31/18
Date: 12/31/18 9/30/18 6/30/18 3/31/18
Assets ($ in Millions): $11,084 $12,558 $12,491 $12,901 Number of Securities: 2,646 2,669 2,644 2,376 Active Share: 22% 22% 24% 24%
Benchmark: MSCI ACWI ex USA
Description: The International Equities Composite represents all International Equity Division investments.
Portfolio Characteristics: SMRS MSCI ACWI ex USA LTM Normalized LTM Normalized Return: Annualized Compound Rate 11.1% 9.8% 9.8% 9.1% Sustainable Growth Rate 7.7% 6.9% 6.9% 6.8% Dividend Yield 2.6% 2.4% 2.7% 2.4% Buyback Yield 0.1% -0.1% 0.3% -0.1% Overlay Yield 0.6% 0.6% -- -- Risk: Beta 1.0 -- 1.0 -- Volatility 14.3% -- 14.4% -- Tracking Error 0.7% -- 0.0% -- Information Ratio 1.8 0.9 -- -- Fundamental: Average Capitalization ($ in Billions) 58.8 -- 61.7 -- Price/Earnings 13.2 16.7 13.9 16.8 Price/Book 1.6 1.9 1.6 1.9 ROE 12.1% 11.2% 11.6% 11.2%
TOP TEN HOLDINGS ($ in Billions* - $ in Millions**)
Portfolio Market FY1 Market Weight Capitalization* P/E Value**
Tencent Holdings Ltd. 1.7% $381.8 31.9 $182.9 Samsung Electronics Co., Ltd. 1.4% 230.5 5.7 158.2 Taiwan Semiconductor Manufacturing Co., Ltd. 1.1% 190.2 16.7 127.1 Roche Holding Ltd. Genusssch 1.1% 212.3 13.8 122.6 Novartis AG 1.1% 217.4 16.4 118.7 Nestle S.A. 1.0% 247.9 20.6 116.0 Alibaba Group Holding Ltd. Sponsored ADR 0.9% 355.3 26.1 100.5 Toshiba Corporation 0.9% 16.6 1.8 96.1 Dai-ichi Life Holdings, Inc. 0.7% 18.8 8.8 74.7 China Construction Bank Co. 0.6% 207.3 5.6 66.2
TOTAL 10.5% $2,078.1 $1,163.1
6 SMRS International Equity By Sector 12/31/18
Real Cash/ Utilities Estate Other 3.5% 3.1% 0.7% Energy 6.7% Financials 19.4%
Materials 6.7%
Communication Services Industrials 7.7% 12.7%
Health Care 9.1% Consumer Discretionary Information 11.4% Technology Consumer Staples 9.1% 9.9%
Market Value in Millions 12/31/18
Assets Percent Benchmark Difference Financials $2,152 19.4% 22.1% -2.7% Industrials 1,408 12.7% 11.7% 1.0% Consumer Discretionary 1,265 11.4% 10.7% 0.7% Consumer Staples 1,103 9.9% 9.6% 0.3% Information Technology 1,007 9.1% 8.1% 1.0% Health Care 1,006 9.1% 8.2% 0.9% Communication Services 850 7.7% 7.6% 0.1% Materials 744 6.7% 7.7% -1.0% Energy 742 6.7% 7.5% -0.8% Utilities 386 3.5% 3.4% 0.1% Real Estate 340 3.1% 3.4% -0.3% Total Investments $11,003 99.3% 100.0% Cash/Other 81 0.7% 0.0% 0.7% Total $11,084 100.0% 100.0%
Benchmark: MSCI ACWI ex USA
7 International Equity Performance - Net of Fees 12/31/18
Inception Fund Name Market Value 1-Year 3-Years 5-Years 7-Years Inception Date
Total International Equity $11,084,104,024 -14.4% 4.6% 1.8% 5.9% 5.0% 1/1/04 MSCI ACWI ex USA -14.2% 4.5% 0.7% 4.8% 5.2% Lipper International Multi-Cap Core -14.4% 3.0% 0.3% 5.3% 4.7% Excess Return -0.2% 0.1% 1.1% 1.1% -0.3% Pct Rank vs. Lipper International Multi-Cap Core 54 18 14 29 31
Total International Active Strategy $4,043,569,979 -15.5% 3.1% 1.2% 5.8% 4.1% 5/1/05 MSCI ACWI ex USA -14.2% 4.5% 0.7% 4.8% 4.5% Lipper International Multi-Cap Core -14.4% 3.0% 0.3% 5.3% 3.9% Excess Return -1.3% -1.4% 0.5% 0.9% -0.4% Pct Rank vs. Lipper International Multi-Cap Core 67 52 21 37 43
LACM World ex USA 853,785,725 -16.8% 1.5% -- -- 1.2% 12/1/15 MSCI World ex USA -14.1% 3.1% -- -- 2.4% Lipper International Multi-Cap Core -14.4% -14.4% -- -- 2.3% Excess Return -2.7% -1.6% -- -- -1.2% Pct Rank vs. Lipper International Multi-Cap Core 80 83 -- -- 78
BlackRock MSCI Systematic Return 825,729,125 ------3.1% 12/1/18 MSCI ACWI ex USA ------4.5% Lipper International Multi-cap Core ------5.0% Excess Return ------1.4% Pct Rank vs. Lipper International Multi-Cap Core ------3
Wellington IRE Fund 629,595,025 -13.5% 3.1% 1.1% 6.3% 3.6% 12/1/05 MSCI World ex USA -14.1% 3.1% 0.3% 5.3% 3.3% Lipper International Multi-Cap Core -14.4% 3.0% 0.3% 5.3% 3.1% Excess Return 0.6% -0.1% 0.8% 1.0% 0.3% Pct Rank vs. Lipper International Multi-Cap Core 29 53 21 22 18
LACM Emerging Markets Fund 339,491,753 -16.3% 8.3% 1.3% 2.9% 3.2% 12/1/09 MSCI Emerging Markets -14.6% 9.3% 1.7% 3.2% 2.6% Lipper Emerging Markets -15.8% 7.0% 0.3% 2.9% 2.4% Excess Return -1.7% -1.0% -0.5% -0.3% 0.7% Pct Rank vs. Lipper Emerging Markets 55 37 42 56 31
Marathon-London International Fund 267,499,358 -14.0% 2.4% 1.8% -- 6.7% 2/1/12 MSCI World ex USA -14.1% 3.1% 0.3% -- 4.5% Lipper International Multi-Cap Core -14.4% 3.0% 0.3% -- 4.4% Excess Return 0.1% -0.7% 1.5% -- 2.1% Pct Rank vs. Lipper International Multi-Cap Core 46 72 14 -- 6
Wellington Emerging Markets Local Equity 257,480,257 -18.8% 7.7% 3.2% 6.1% 5.4% 12/1/11 MSCI Emerging Markets -14.6% 9.3% 1.7% 3.2% 3.0% Lipper Emerging Markets -15.8% 7.0% 0.3% 2.9% 2.5% Excess Return -4.2% -1.6% 1.4% 2.9% 2.4% Pct Rank vs. Lipper Emerging Markets 78 46 8 8 8
Effissimo Capital Management Japan 222,424,393 -19.1% 3.0% -- -- 3.0% 12/1/15 MSCI Japan -12.9% 3.4% -- -- 3.4% Lipper International Small/Mid-Cap Value -19.5% 3.1% -- -- 2.6% Excess Return -6.2% -0.4% -- -- -0.4% Pct Rank vs. Lipper International Small/Mid-Cap Value 26 63 -- -- 51
SSGA International Alpha Small Cap 218,234,345 -18.6% 1.8% 2.1% 8.6% 2.6% 5/1/07 MSCI World ex USA Small Cap -18.1% 3.9% 2.3% 7.4% 2.0% Lipper International Small/Mid-Cap Core -18.6% 2.4% 0.9% 6.0% 1.2% Excess Return -0.5% -2.0% -0.1% 1.2% 0.6% Pct Rank vs. Lipper International Small/Mid-Cap Core 41 67 27 81
Lazard/Wilmington International Equity 218,025,000 -13.5% 0.7% -- -- -0.7% 6/1/14 MSCI World ex USA -14.1% 3.1% -- -- -0.5% Lipper International Large-Cap Core -14.4% 3.0% -- -- -0.4% Excess Return 0.6% -2.4% -- -- -0.2% Pct Rank vs. Lipper International Large-Cap Core 29 92 -- -- 77
Martin Currie International Long-term Unconstrained 211,301,807 -11.3% ------3.9% 2/1/17 MSCI ACWI ex USA -14.1% ------1.9% Lipper International Multi-Cap Core -14.4% ------1.7% Excess Return 2.8% ------2.1% Pct Rank vs. Lipper International Multi-Cap Core 15 ------7
8 Inception Fund Name Market Value 1-Year 3-Years 5-Years 7-Years Inception Date
Total International Stock Plus Strategy $3,867,460,721 -13.6% 5.8% 2.4% 6.7% 6.3% 1/1/09 MSCI ACWI ex USA -14.2% 4.5% 0.7% 4.8% 6.6% Lipper International Multi-Cap Core -14.4% 3.0% 0.3% 5.3% 6.3% Excess Return 0.6% 1.4% 1.8% 1.9% -0.3% Pct Rank vs. Lipper International Multi-Cap Core 32 3 912 46
Internal Stock Plus 2,310,747,835 -12.4% 4.7% 2.3% 4.7% 4.0% 9/1/11 MSCI ACWI ex USA -14.2% 4.5% 0.7% 4.8% 3.5% Lipper International Multi-Cap Core -14.4% 3.0% 0.3% 5.3% 3.9% Excess Return 1.8% 0.2% 1.6% -0.2% 0.5% Pct Rank vs. Lipper International Multi-Cap Core 21 15 883 57
PIMCO StockPLUS International TR Fund 1,054,605,425 -15.1% 3.9% 0.4% 6.8% 4.8% 10/1/10 MSCI World ex USA -14.1% 3.1% 0.3% 5.3% 3.7% Lipper International Large-Cap Core -14.4% 3.0% 0.3% 5.3% 3.5% Excess Return -1.0% 0.7% 0.1% 1.6% 1.1% Pct Rank vs. Lipper International Large-Cap Core 64 32 61 9 12
PIMCO Emerging Markets StockPLUS AR Fund 502,107,462 -16.0% 10.4% -- -- 1.9% 4/1/15 MSCI Emerging Markets -14.6% 9.3% -- -- 2.2% Lipper Emerging Markets -15.8% 7.0% -- -- 1.1% Excess Return -1.5% 1.1% -- -- -0.3% Pct Rank vs. Lipper Emerging Markets 52 13 -- -- 26
Total International Index Strategy $3,173,073,324 -12.0% 5.7% 2.3% 5.7% 6.8% 7/1/09 MSCI ACWI ex USA -14.2% 4.5% 0.7% 4.8% 5.5% Lipper International Multi-Cap Core -14.4% 3.0% 0.3% 5.3% 5.6% Excess Return 2.2% 1.2% 1.6% 0.9% 1.3% Pct Rank vs. Lipper International Multi-Cap Core 20 3 93111
SSGA MSCI ACWI ex USA Index 1,994,110,712 -14.0% ------9.7% 11/1/17 MSCI ACWI ex USA -14.2% ------10.0% Lipper International Large-Cap Core -14.4% ------10.6% Excess Return 0.2% 0.3% Pct Rank vs. Lipper International Large-Cap Core 43 ------25
BlackRock MSCI ACWI ex USA Index 1,178,962,613 ------14.5% 3/1/18 MSCI ACWI ex USA ------14.7% Lipper International Large-Cap Core ------14.1% Excess Return ------0.2% Pct Rank vs. Lipper International Large-Cap Core ------58
9 State of Michigan Retirement System REAL ESTATE AND INFRASTRUCTURE REVIEW State of Michigan Investment Board Meeting March 7, 2019
Todd A. Warstler Senior Investment Manager Real Estate and Infrastructure Division EXECUTIVE SUMMARY
Performance
MPSERS Plan (12/31/18) 1-Year 3-Years 5-Years 7-Years 10-Years Annualized Returns 12.2% 10.4% 12.0% 11.5% 5.6% NCREIF NPI 5.4% 5.8% 7.9% 8.3% 6.1% Peer Median Returns 8.9% 8.7% 10.5% 10.2% 5.7% Percentile Rank vs. Peers* 4 29 21 27 51 *State Street Universe greater than $1 billion
Outperformance relative to the one-year benchmark resulted from the Real Estate and Infrastructure Division’s (REID) strategy of being underweight in retail, overweight in hotels, team selectivity within the apartment sector, several favorable sale executions in the real estate portfolio, and appreciation and gains in the infrastructure portfolio.
Strategy Update
The REID is focusing on sourcing off-market opportunities through its extensive network and reducing risk in the portfolio through early income-generating investments including credit strategies that are higher in the capital stack with a shorter projected hold period. The REID has selectively acquired properties where it can add value through management and leasing and has continued to develop properties at attractive risk-adjusted returns. The REID will continue its strategy of assembling portfolios in both traditional and non-traditional real estate sectors that REID believes will become institutional property types, providing above market appreciation and total returns.
The REID has been actively managing the portfolio with dispositions resulting in capital returned in excess of $2.1 billion, and funding new investments of nearly $1.9 billion over the past 12 months. The REID is working with its advisors in executing the disposition of properties and realizing gains from the sale of assets at historically low capitalization rates where these opportunities exist.
The REID has approximately $1.5 billion in unfunded commitments. New commitments during the quarter include:
o $200 million in Blackstone Real Estate Partners IX, LP, a commingled fund specializing in large, global, opportunistic real estate transactions, managed by Blackstone Real Estate Advisors.
o $200 million in Lone Star Fund XI, LP, a commingled fund specializing in global opportunistic real estate credit strategies, managed by Lone Star.
Market Environment
Fund flows to the real estate sector remain strong, the average allocation to real estate globally is 10%, up significantly from last year (8.9%) and below the average target of 10.4%. Retail properties continue to be less attractive to investors as e-commerce sales continue to grow with investors instead favoring warehouse (as a retail substitute in
1 some cases) and apartments. Senior housing, student housing, data centers and medical office once considered niche are attracting more investor attention. Supply of new buildings in all property types, except retail, has increased in many markets and is beginning to raise concern from investors. However, a strong economy has so far kept demand for space high enough to absorb new supply. Additionally, lenders have become more selective in quality and location of the collateral and have been disciplined in their underwriting standards for construction lending. The cost of new construction in land, labor and materials has steadily increased, making it more difficult for developers to meet return thresholds.
The passage of the U.S. tax reform bill is generally viewed as favorable to the real estate industry. Economic growth from companies increasing investment in their U.S. business operations would increase demand for office labor and industrial space. Real estate developers will benefit from a lower pass-through tax rate. The increase in the standard deduction could further delay apartment renters from purchasing a home.
Fund flows to the infrastructure sector also remain strong, as investor interest in the asset class continues to grow. Opportunities include North American energy, power generation, European transportation, and emerging market fundamental infrastructure projects. The industry has gained attention from the Federal Administration’s intent on rebuilding U.S. infrastructure; however, details on legal and financial framework of Public Private Partnerships (P3) are limited and will take time to develop. A tight labor market for construction workers and political gridlock in Washington could inhibit timing of funding and completions.
Tightening lending standards combined with heightened bank regulations after the global financial crisis have worked to constrain lending activity in many instances. Demand for private credit from non-traditional capital providers, particularly when a financial sponsor requires speed and certainty of execution is expected to continue to grow. Real estate credit in the U.S., Europe and Asia in various forms should continue to present opportunities.
2 SMRS Real Estate and Infrastructure 12/31/18
Cash/ FS Land Homes Other FR 1.5% 0.8% Homes 3.5% 4.5% Retail 4.9%
Apartment Industrial 39.0% 8.7%
Infrastructure 11.7%
Office 12.2% Hotel 13.2%
Market Value in Millions 12/31/18 12/31/17 Apartment $2,747 39.0% $2,302 33.1% Hotel 927 13.2% 936 13.4% Office 857 12.2% 1,131 16.3% Infrastructure 826 11.7% 822 11.8% Industrial 610 8.7% 538 7.7% Retail 346 4.9% 315 4.5% For Rent Homes 315 4.5% 353 5.1% For Sale Homes 249 3.5% 321 4.6% Land 108 1.5% 106 1.5% $6,985 99.2% $6,824 98.0% Cash/Other 60 0.8% 140 2.0% Total Investments $7,045 100.0% $6,964 100.0%
3 SMRS Real Estate by Region Based on Market Value (excludes cash & cash equivalents) 12/31/18
Pacific 21.1% Northeast West N. Central 13.5% East N. Central Mountain 1.9% 7.6% 4 9.6%
Mideast 13.3%
Southeast Southwest 12.7% 13.4%
International comprises 6.9%
Geographic regions defined by NCREIF, whose property index composition is: Pacific 33.0%, Mountain 6.4%, West N. Central 1.2%, Southwest 10.4%, East N. Central 7.3%, Southeast 9.7%, Northeast 20.4%, Mideast 11.6% SMRS Real Estate and Infrastructure 12/31/18
Top Ten Advisors or Entity
Advisor or Entity Market Value MWT Holdings LLC $ 2,125,983,103 Clarion Partners 665,084,656 Blackstone Group 538,060,255 Five Star Realty Partners LLC 355,720,485 Rialto Capital Management LLC 316,182,901 Principal Real Estate Investors 307,871,264 Domain Capital Advisors Inc 271,989,670 CIM Investment Advisors LLC 256,590,994 Transwestern Investment Management 184,762,083 L&B Realty Advisors 164,969,786 $ 5,187,215,197
Occupancy by Property Type
Apartment Office Industrial Retail Hotel SMRS Portfolio 95.6% 86.8% 93.2% 90.7% 74.7% National Average N/A* 87.4% 93.0% 95.6% 61.9%
*Note: 4Q18 Data not published due to Federal Government shutdown.
5
SMRS Market Values by Ownership Entity 12/31/18 REAL ESTATE Unfunded Market Value Commitment 801 Grand Avenue Capital, LLC $ 69,912,156 $ 0 AEW Senior Housing III 2,824,251 1,868,411 Apollo Asia Real Estate Fund 22,545,374 51,116,044 Asana Partners Fund I 20,717,029 6,916,828 Avanath Affordable Housing I, LLC 23,900,166 0 Avanath Affordable Housing II, LLC 33,491,618 0 Avanath II SMRS Co-Investment Fund LLC 15,076,524 0 Avanath Affordable Housing III 32,663,628 33,820,867 Blackstone R/E IH3 Co-Inv Partners 314,634,650 0 Blackstone R/E Partners V, LP 5,882,881 0 Blackstone R/E Partners VI, LP 7,761,334 3,680,930 Blackstone R/E Partners VIII, LP 57,976,052 28,067,648 * Blackstone R/E Partners IX, LP 0 200,000,000 Capri Select Income II 59,874 0 Capri Urban Investors, LLC 8,514,703 0 CIM Fund III, LP 39,965,807 0 CIM Fund VIII, L.P. 101,272,166 16,336,387 CIM Urban REIT, LLC 43,067,986 0 CIM VI (Urban REIT), LLC 30,451,331 0 Clarion Gables Multifamily Trust, LP 30,906,357 0 Columbus Circle Holdings, LLC 163,522,140 139,272,720 Crown Small Cap Real Estate 16,602,572 8,375,000 Domain GVA-1, LLC 39,887,441 2,487,251 Domain Hotel Properties, LLC 415,742,465 0 Gateway Capital Real Estate Fund II, LP 36,055,707 0 Great Lakes Property Group Trust 68,269,447 10,000,000 Heitman Credit 50,007,811 0 IMRF II CoInvest Spiga LP 13,474,402 4,265,944 Invesco Mortgage Recovery Feeder Fund 5,362,102 0 Invesco Mortgage Recovery Fund II, L.P. 36,073,034 40,985,873 IPF II Co-Invest Cayman LP 27,543,845 2,495,897 JBC Funds North LaSalle LLC 19,305,175 0 JBC Opportunity Fund III, LP 495,673 0 JP Morgan India Property Fund II, LLC 31,472,624 3,576,116 KBS/SM Fund III, LP 48,579,637 0 KBS/SM Fund IV 317,619 0 L-A Saturn Acquisition 31,153,031 0 Landmark Real Estate Partners V, LP 9,007,931 0 LaSalle Asia Opportunity Fund II, LP 277,310 0 LaSalle Asia Opportunity Fund III, LP 1,678,375 0 Lion Industrial Trust 211,905,329 0 Lion Mexico Fund, LP 6,530,505 0 Lombard GVA0016 (former AGL Annuity) 360,153,510 0
6
Unfunded Market Value Commitment Lone Star Fund X LP $ 98,836,481 $ 107,927,266 * Lone Star Fund XI LP 0 200,000,000 Lubert-Adler Real Estate Fund VII, LP 62,266,670 6,222,826 M1 Westgate CoInvest LLC 18,431,048 0 M301W CoInvest LLC 23,402,656 0 MERS Acquisitions Ltd. 164,969,786 27,400,000 MG Alliance, LLC 122,385 0 MIP Holdco LLC 127,753,558 38,300,000 MSREF V - International 2,477,985 0 MSREF VI - International 4,548,738 0 MSRESS Fund III Institutional LP 19,131,691 0 MWT Holdings, LLC 2,125,983,103 0 Northpark Land Associates 32,624,178 13,330,514 Paladin Realty Brazil Investors III (USA), LP 17,630,011 0 Paladin Realty Latin America Investors IV-CI, LP 45,121,674 0 Paladin Realty TB COINV V LP 9,981,102 0 Penmain Office LLC 35,955,911 0 Principal Separate Account 237,959,108 89,521,493 Proprium RE Spec. Situations Fund, LP 55,055,727 23,799,884 Rialto Absolute Partnership I 75,244,827 0 Rialto Credit Partshp LP 107,502,557 35,000,000 Rialto Real Estate Fund, LP 20,201,691 0 Rialto Real Estate Fund II, LP 37,251,713 0 Rialto Real Estate Fund III-Debt, LP 31,972,723 26,063,270 Rialto Real Estate Fund III-Property, LP 16,799,953 29,315,069 Rialto Mezzanine Partners Fund 27,209,437 0 SM Brell II LP 26,666,435 0 Stockbridge RE Fund II-C, LP 25,980,653 0 Strategic LP 18,933,776 0 Strategic II LLC 711,971 49,228,078 TPG RE Finance Trust Inc. (TRTX) 88,187,144 0 TPG Real Estate Partners II 28,904,575 15,678,032 TPG Real Estate Partners III, LP 0 50,000,000 TSP Spartan C-I LLC 158,023 0 TSP Spartan C-II LLC 18,478,924 0 TSP Value and Income Fund LP 25,593,930 0 TSP Value and Income Fund II, LP 12,777,648 36,977,285 True North High Yield Invest. Fund II, LLC 4,197,007 0 True North Real Estate Fund III, LLC 44,790,904 9,348,297 Venture Center, LLC 787,140 0 Western National Realty Fund II, LP 7,016,041 0 $ 6,156,660,462 $ 1,311,377,930 Short-Term Investments and Other 46,072,730 0 Total Real Estate Investments $ 6,202,733,191 $ 1,311,377,930 * New or additional commitment made during the quarter reported
7 SMRS Market Values by Ownership Entity 12/31/18
INFRASTRUCTURE Unfunded Market Value Commitment Arclight Energy Partners VI, LP$ 45,116,960 $ 9,081,559 ASF VI Infrastructure B LP 19,097,962 14,864,229 ASF VII Infrastructure Fund B L.P. 3,031,690 27,892,271 ASF Como Co-Investment LP 6,953,500 3,004,353 Basalt Infrastructure Partners, LP (Balfour Beatty) 46,954,403 2, 219,045 Blackstone Energy Partners, LP 53,393,225 4,702,610 Blackstone Energy Partners II, LP 68,152,775 30,275,244 Brookfield Infrastructure Fund II-B, L.P. 53,070,559 5,036,523 Customized Infrastructure Strategies, LP 45,184,246 5,661,912 Dalmore Capital Fund 64,366,859 0 GCM Grosvenor Infrastructure Investment Program, L.P. (CSG) 77,017,048 0 GCM Grosvenor Customized Infrastructure Strategies II, L.P. 36,042,469 19,238,579 Global E&P Infrastructure Fund II L.P. (formerly First Reserve) 51,671,170 17,588,817 GSO Energy Select Opportunities Fund LP 30,259,338 25,684,982 JPMorgan AIRRO India SideCar Fund US, LLC 78,978,353 3,187,421 JPMorgan Asian Infra. & Rel. Res. Opp Fund II 10,794,994 7,440,09 4 KKR Eagle CoInvest L.P. 35,913,836 1,853,268 KKR Global Infrastructure Investors, LP 38,778,953 4,182,224 Ridgewood Water & Strategic Infrastructure Fund LP 4,767,046 45,2 00,000 RPEP SMRS Infra II, LLC 2,250,565 500,000 StonePeak Infrastructure Fund LP 54,218,653 11,387,841 $ 826,014,603 $ 239,000,972 Short-Term Investments and Other 16,264,971 0 Total Infrastructure Investments $ 842,279,574 $ 239,000,972
TOTAL INVESTMENTS $ 7,045,012,765 $ 1, 550,378,902
8 State of Michigan Retirement System BASKET CLAUSE REVIEW State of Michigan Investment Board Meeting March 7, 2019
Karen M. Stout, CPA, CGFM Administrator Trust Accounting Division SMRS Basket Clause Investments 12/31/18
Asset Class Value
Total Absolute Return $ 4,211,987,530
Total Real Return and Opportunistic 951,755,573
Total International Equity 222,424,394
Total Fixed Income 56,081,035
Total Basket Clause Investments $ 5,442,248,532
The basket clause investments at December 31, 2018, were $5.4 billion or 7.8% of the total portfolio value of $69.5 billion.
The Public Employees Retirement System Investment Act, 1965, PA 314, MCL 38.1132 et seq , authorizes the State Treasurer to invest up to 30% of the system's assets in investments "not otherwise qualified under the act." MCL 38.1140d (1). Commonly referred to as Section 20d (after the authorizing section of PA 314) or Basket Clause investments, this provision gives the State Treasurer the flexibility to take advantage of market opportunites not specifically aurhorized in PA 314 while conserving protections against imprudent investment. Disclaimer
This presentation was given solely for the purpose of explaining the structure, investment process, and returns for the State of Michigan Retirement System. It should not be interpreted in any way as financial advice.